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Since 2022, I’ve focused on the relationship between labor and Fed policy. There’s a common belief that a decrease in the inflation growth rate would lead to mortgage rates dropping below 6% as the Fed would cut more aggressively. However, we haven’t seen that improvement.
Today’s soft Consumer Price Index (CPI) inflation report indicates progress. However, it also highlights that we are still adjusting to the pandemic-related inflation that arose when supply chains were disrupted and recovered. Before 2025, the Federal Reserve indicated that they considered two rate cuts while highlighting their approach to achieving a neutral policy stance. The emergence of a trade war introduces new complexities to the situation. As a result, policymakers may be compelled to wait until the labor market demonstrates more pronounced signs of distress before signaling to the marketplace their intention to ease policies further.
CPI inflation was by design
Due to the unsustainable nature of pandemic-induced inflation, the growth rate of inflation was destined to decline, independent of the Federal Reserve’s actions. However, the Federal Reserve aimed to implement a restrictive policy by maintaining the Fed Funds rate above the inflation growth rate for an extended period. This approach is intended to soften the labor market and moderate wage growth. As shown below, we have made significant progress in reducing the growth rate of inflation.
The Federal Reserve has adjusted its inflation expectations since the trade war and may consider further adjustments as circumstances evolve. Consequently, if the labor market remains firm, the decision to lower interest rates may be approached with increased caution.
Labor data steady
Today, the jobless claims data came in fine, with the headline figure at 223,000. My threshold for recessionary signals is a four-week moving average of jobless claims heading toward and exceeding 323,000. The four-week moving average today is also at 323,000.
The Fed has consistently stated that they monitor these jobless claims closely, and there’s no indication that they feel the need to cut rates beyond what they projected for 2025, which only includes rate cuts.
The upcoming unemployment numbers will be critical since they have already revised their unemployment rate target this year. If the trade war affects the economy more, we could see significant implications for the unemployment rate.
Even before the trade war began, the Federal Reserve had made it clear that they would cautiously approach interest rate cuts in 2025. Now, with the recent decision to raise inflation targets and uncertainty about the trade war’s potential impact on the economy, it is unlikely that we will hear a dovish tone from them until the labor market shows significant signs of weakness. This reinforces that the Fed is committed to maintaining control over inflation despite the broader economic challenges ahead, even with today’s softer CPI inflation print.
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