US monetary policy: More to worry about than just rates

The US central bank is often in the news, and the Federal Reserve is likely to start cutting rates again shortly. However, intense political pressure has thrown something else into the mix and US central bank independence has become a (previously unlikely) talking point.

I am pencilling in two rate cuts this year and a further two 25bps cuts before the end of 2027. That’s roughly in line with the median Federal Open Market Committee (FOMC) participant forecast from June. Revised payroll figures, however, suggest that the US labour market is much weaker – and has been for some time – than was apparent the last time the FOMC met in July. A deteriorating labour market could justify more cuts, going below the Fed’s estimate of neutral.

The FOMC participants’ median longer-run Fed funds rate forecast is 3.0% – arguably a proxy for their central case view on neutral. With a current Fed funds target of 4.25% to 4.50%, “going below neutral” could clearly justify more than 100bps of rate cuts (subject to the usual caveats around how uncertain the neutral rate is). 

Rate cuts seem likely in the coming months against a backdrop of what I expect to be relatively modest domestic demand growth by US standards, a weaker labour market, and (only) a temporary and measured rise in US inflation on the back of tariff increases.

After the recent weak employment reports, a September rate cut looks likely. The rise in non-farm payrolls in August was lower than expected but, importantly, was accompanied by substantial downward back revisions, painting a much weaker picture of the US labour market than had previously been the case. The September payrolls figures were weaker again and the Bureau of Labor Statistics (BLS) released sizeable downward preliminary back-revisions for the 12 months to March 2025. The Federal Reserve, with its mandate of maximum employment (alongside price stability), was always going to be sensitive to a ‘turn’ in the labour market.

Fed Chair Jerome Powell’s late August speech at Jackson Hole was also consistent with a September rate cut, marking a surprising pivot from previously sounding more balanced on the near-term outlook. There was his dovish take on labour market developments, saying that the unusual situation of labour market balance resulting from slowing both the demand and supply of workers “suggests that downside risks to employment are rising”. He said that “if those risks materialise, they can do so quickly in the form of sharply higher layoffs and rising unemployment”. Although he also said that inflation risks were “tilted to the upside”, towards the end of his speech he said that “with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance”.

Risks to my central case are not only in the direction of more cuts. Inflation may well turn out to be stronger and more persistent, and there are risks to the amount of slack in the labour market.

Market pricing itself also makes a September rate cut more likely (markets are fully priced for a September rate cut), with the FOMC likely reluctant to surprise markets. But a series of rate cuts this year and next is far from a done deal. Several FOMC participants are currently signalling a degree of caution around cutting rates, despite the labour market data. Inflation remains something of a concern. Risks to my central case are not only in the direction of more cuts. Inflation may well turn out to be stronger and more persistent than expected (services inflation was surprisingly robust in July and August) and there are two-sided risks to the amount of slack in the labour market. Changes in labour demand are also accompanied by changes in labour supply following immigration policy developments. The unemployment rate has not been trending anywhere so far this year.

What about the element of political pressure? A 25bps cut in September arguably looks more conservative and independent of political pressure than it would have done, following US Treasury Secretary Scott Bessent saying he thought the Fed could start a series of rate cuts starting with a 50bps cut in September. However, it is no secret that US President Donald Trump wants interest rates to be cut a lot (including calling for 300bps of rate cuts in July). Bessent has said that “if you look at any model”, rates should “probably be 150, 175 basis points lower”.

Trump’s firing of Federal Reserve Board member Lisa Cook has shaken things up again, with the case hitting the courts. If Cook departs, that will give Trump-appointees (after Senate approval) a majority on the seven-member board. The board, when adding five voting and rotating regional Reserve Bank presidents, forms the FOMC (the body that decides monetary policy). Trump has arguably fanned the flames of worry about what all this means for monetary policy independence with his comment on 26 August that “we’ll have a majority very shortly”.

Fed-related news flow is likely to remain strong in coming months. Not only do I think that they will likely restart rate cuts, but there is also the potential court case, the upcoming board nomination, and plans to pick the next Fed chair.

Fed-related news flow is likely to remain strong in coming months. Not only do I think that they will likely restart rate cuts, but there is also the potential court case, plans to pick the next Fed chair which are underway, and we have already had one set of hearings for a board nomination. Stephen Miran looks set to replace Adriana Kugler (who stepped down in August), despite (only) taking a leave of absence from his role as chair of the White House’s Council of Economic Advisers rather than resigning. 

Going into next year there is also the question of whether Powell steps down from the board when his term as Fed chair ends in May (he does not have to as his term as a board member does not end until January 2028). If he stays, the market might view that as a bulwark against political influence. It is also worth noting that the board also approves the appointments of each Reserve Bank’s president, and the terms of those presidents run concurrently with current terms set to end in February 2026.

Perhaps worries around independence will be water under the bridge by the end of the year if the Fed are firmly in rate cutting mode in reaction to data developments. Existing Trump-appointees Christopher Waller and Michelle Bowman justified support for a rate cut in July on perfectly reasonable economic grounds (contending that higher tariffs were unlikely to have persistent effects on inflation and that downside risks to the labour market had risen). So far, data is on their side.

Central bank independence, however, is frequently seen as a cornerstone of inflation control. Central banks independent of politics lack the need to be ‘popular’. They are therefore seen as more willing to take tough decisions (ie rate hikes) to control inflation. If this further evolves into a point of substantial compromise around Fed monetary policy independence, that would be a serious concern. 

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