Divided Fed Navigates Employment Risks vs. Inflation as Rate Cut Splits Emerge

The Federal Reserve's Federal Open Market Committee (FOMC) has signaled a significant shift in monetary policy, with its members broadly endorsing further interest rate cuts in 2025 and 2026 to address a weakening labor market and moderating inflation. On September 17, 2025, the Fed reduced the federal funds rate by 25 basis points to a range of 4.00%-4.25%, marking its first cut since December 2024. This decision followed a sharp slowdown in job growth, with the unemployment rate rising to 4.3% in the third quarter of 2025, as well as revised downward projections for economic activity. The FOMC's summary of economic projections (SEP) indicates a median forecast of two additional 25-basis-point cuts in 2025 and one in 2026, bringing the target rate to 3.25%-3.50% by year-end 2026. These cuts reflect the committee's prioritization of employment risks over inflation, which remains above the 2% target but is expected to stabilize.

The Fed's decision was influenced by deteriorating labor market conditions, as highlighted by recent data showing a decline in job-finding rates and a precarious balance between labor supply and demand. Chair Jerome Powell emphasized that "downside risks to employment have risen," noting that recent labor data revealed challenges for "people at the margins," including recent college graduates. The Chicago Fed's new labor market indicators, released in September, corroborate this assessment, projecting the civilian unemployment rate to remain stable at 4.3% in September 2025. However, the indicators also suggest a growing risk of a self-reinforcing cycle of layoffs and reduced spending if labor demand continues to contract.

While the Fed acknowledges that inflation remains a concern, it has downgraded its urgency relative to employment. The SEP forecasts core inflation-excluding volatile food and energy prices-to settle at 2.6% by the end of 2026, with the pass-through of President Trump's tariffs deemed "smaller and slower" than previously anticipated. This contrasts with external analyses, such as Morningstar's projection of 3.2% core inflation in 2026, which incorporates higher inflationary pressures from tariffs. The Fed's stance is further reinforced by Stephen Miran, the newly confirmed FOMC member, who has advocated for more aggressive rate cuts. Miran, a Trump appointee, was the sole vote for a 50-basis-point cut in September and has projected a target rate of 2.75%-3.00% by the end of 2025-a stance that diverges from the median FOMC outlook.

The FOMC's projections reveal a deep division among policymakers about the pace of rate cuts. While the median forecast assumes two 25-basis-point reductions in 2025 and one in 2026, nine of 19 members do not anticipate further cuts this year. Miran's advocacy underscores this divergence, as his projections-calling for a 1.25-point reduction by year-end 2025-contrast sharply with the more cautious majority. Oxford Economics analysts noted that Miran's late addition to the FOMC limited his influence on immediate policy, but his presence could shape future debates. The Fed's October and December meetings will be critical in determining whether the pace of cuts aligns with the median projection or accelerates to match Miran's more aggressive stance.

Market expectations have also adjusted to the Fed's signals, with investors pricing in approximately 0.75 points in cuts for 2026, exceeding the FOMC's current median forecast. This discrepancy reflects uncertainty about the trajectory of inflation and the labor market, particularly as tariffs on imports from China, Vietnam, and other countries continue to exert upward pressure on prices. The Bureau of Labor Statistics reported a 3.1% year-over-year increase in core inflation in August 2025, driven by price hikes in tariff-sensitive categories such as coffee, household furnishings, and apparel. However, the Fed's preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, is projected to decline to 2.6% by 2026, reflecting its assessment that tariff-driven inflation will be a temporary shock.

The Fed's rate cuts are expected to have mixed effects on households and businesses. Variable-rate loans, such as credit cards and adjustable-rate mortgages, will see immediate benefits, with prime rates declining in tandem with the federal funds rate. However, fixed-rate mortgages and auto loans are unlikely to drop significantly in the short term, as their rates are more closely tied to Treasury yields and broader economic conditions. For savers, the cuts will likely erode returns on high-yield savings accounts and certificates of deposit, with analysts advising consumers to lock in current rates before further reductions.

Source: [1] Morningstar.com (https://www.morningstar.com/economy/fed-cuts-rates-signals-more-come-2025)

[2] CBS News (https://www.cbsnews.com/news/federal-reserve-fomc-meeting-today-rate-cut-september-2025-powell-impact)

[3] Fox Business (https://www.foxbusiness.com/economy/what-feds-outlook-interest-rate-cuts-inflation-jobs-remainder-year)

[4] The New York Times (https://www.nytimes.com/live/2025/08/12/business/cpi-inflation-tariffs-fed)

[5] CNBC (https://www.cnbc.com/2025/09/13/charts-how-much-costs-have-risen-since-trump-tariffs-went-into-effect.html)