Fed's Cautious Cuts Clash with ECB's Aggressive Easing as Divergence Grows

The Federal Reserve's September 2025 meeting marked a pivotal moment in its ongoing effort to navigate a slowing economy, with the central bank cutting the federal-funds rate by 0.25 percentage points to a target range of 4.00%-4.25%. The decision, which saw 11 of 12 FOMC members vote for the cut, was driven by deteriorating labor market conditions and heightened downside risks to employmentMorningstar.com, ^[1]. The lone dissenter, newly confirmed Fed Governor Stephen Miran, advocated for a more aggressive 0.50% reduction, reflecting his belief that structural shifts-including immigration, tariffs, and regulatory changes-have pushed the "neutral" rate downwardMorningstar.com, ^[1]. Miran's stance aligns with the Trump administration's push for looser monetary policy, though his projection of a 2.75%-3.00% rate by the end of 2025 remains short of Trump's stated goal of 1.25%-1.50%Morningstar.com, ^[1].

The FOMC's updated Summary of Economic Projections (SEP) revealed a cautious path forward, with the median participant forecasting a further 0.5% rate cut in 2025 and an additional 0.25% reduction in both 2026 and 2027Crestwood Advisors, ^[2]. However, Miran's outlier projection-a target range of 2.25%-2.50% by 2027-highlighted divergent views within the committee. The broader projections suggest a gradual easing, with the rate expected to fall to 3.50%-3.75% by the end of 2025 and 3.25%-3.50% by 2026Morningstar.com, ^[1]. These forecasts contrast with market expectations, which priced in a 0.75% cut for 2026 as of September 2025Morningstar.com, ^[1]. Analysts at Morningstar, meanwhile, anticipate a 3.00%-3.25% range by the end of 2026, underscoring uncertainty about the pace of economic slack and inflationary pressuresMorningstar.com, ^[1].

The government shutdown, which began on October 1, 2025, has added another layer of complexity to the Fed's policy calculus. This shutdown, the first to affect all federal agencies due to the absence of prior funding bills, has led to furloughs for approximately 40% of non-essential federal employeesCrestwood Advisors, ^[2]. While the immediate economic impact is limited to temporary unemployment for affected workers, the shutdown's ripple effects-such as reduced TSA staffing and USDA inspections-could disrupt key sectors. Historically, markets have shown muted reactions to such events, with equity indices like the S&P 500 and ACWI posting gains in September 2025 amid the rate cut backdropCrestwood Advisors, ^[2]. However, the prolonged closure raises questions about its influence on consumer and business confidence, particularly as the first at-risk military pay date approaches on October 15Crestwood Advisors, ^[2].

The Fed's rate path is increasingly diverging from that of the European Central Bank (ECB), with transatlantic monetary policy trajectories set to diverge sharply in 2025. While the FOMC projects a cumulative 0.75% reduction by year-end, the ECB is expected to cut rates by over 1.5 percentage points, driven by weaker growth and disinflationary trends in the EurozoneFinancial Times, ^[3]. This divergence stems from contrasting economic fundamentals: US inflation, though easing, remains above 2% due to Trump's tariff policies, while Eurozone inflation is projected to fall below the ECB's 2% target as early as February 2025Financial Times, ^[3]. Capital Economics' Jennifer McKeown notes that the Fed's cautious approach is necessitated by inflation risks, whereas the ECB faces mounting pressure to stimulate a struggling economyFinancial Times, ^[3]. The dollar has already rallied against the euro, reflecting these shifting dynamics, with the euro hitting a near-two-year low amid expectations of aggressive ECB easingFinancial Times, ^[3].

The Fed's independence, emphasized by Chair Jerome Powell, remains a critical factor in its policy decisions. Despite Miran's advocacy for more aggressive cuts, the central bank's structure-designed to insulate it from political pressures-suggests a measured approachMorningstar.com, ^[1]. However, the interplay between Trump's economic agenda and the Fed's mandate could complicate this independence, particularly if inflationary pressures from tariffs persist. Analysts at Swiss Re and BNP Paribas note that while US growth outperformance is expected to continue in 2025, the risk of a trade war escalation could amplify downside risks, particularly for global growthSwiss Re Institute, ^[4].