Fed is taking the no-risk free path to cuts

As widely expected, at its September meeting the Federal Open Market Committee (FOMC) decided to lower its benchmark policy rate by 25 basis points to 4.00%-4.25%. Only one official voted to dissent, preferring a larger 50 basis point cut.

Today’s decision was characterized as a “risk management cut,” an acknowledgement of the labor market risks but also the elevated uncertainty around inflation and government policy. We expect two more 25 basis point cuts this year as the Fed gradually reduces rates to below most measures of neutrality.

Current assessment

Labour and inflation: Fed Chair Jerome Powell emphasized that the balance of risks has shifted firmly toward the full employment side of its dual mandate. Signs of weaker labor demand have become more apparent, while the impact of tariff-induced price increases on inflation appears to be more modest than originally expected. In addition, given the ongoing slowdown in the labor market and cooling wages, the risk of runaway inflation has likely reduced.

Structural shifts: At the same time, labor dynamics have been shifting. As Powell noted, decelerating immigration has driven a drop in labor supply, pushing down the breakeven rate of employment growth and putting the labor market in a “curious” balance. The end picture is one of only a modestly weaker jobs market, even as monthly payroll growth has dropped meaningfully.

Fed independence: President Donald Trump’s latest Fed appointee and close ally, Stephen Miran, was among those voting in today’s decision and the lone dissenter. As expected, Powell declined to entertain speculation around the politicization of the Fed, instead just emphasizing its independence and continued focus on the dual mandate.

Updates to the Summary of Economic Projections

The new Summary of Economic Projections was also released today. It showed the Fed’s focus on the employment side of its dual mandate, with the median projection showing another two 25 bps rate cuts this year, albeit in a very narrow margin.

• The GDP growth forecast was revised up from 1.4% to 1.6% for 2025, from 1.6% to 1.8% for 2026, and from 1.8% to 1.9% for 2027. The upward revisions likely speak to the gentle recovery expected by the Fed, which is also reflected in consensus forecasts.
• The unemployment rate forecast was left unchanged at 4.5% in 2025, but is expected to dip to 4.4% in 2026 and 4.3% in 2027. This unusual dynamic of cutting rates into declining unemployment likely reflects the Fed’s view that structural factors are leading to a shrinking of labor supply, keeping the labor market broadly in equilibrium.
• The headline PCE inflation forecast for 2025 and 2027 was left unchanged at 3.0% and 2.1% respectively, while 2026 was revised up from 2.4% to 2.6%. The upward revision just for 2026 indicates that the FOMC still expects tariffs to have only a one-time price increase effect, though risks remain particularly heightened given how difficult it is to forecast the impact of the tariffs.

The revised SEP forecasts for 2025 are similar to our own, if not a touch more optimistic. We expect GDP growth this year of 1.6%, inflation to reach 2.9%, and unemployment to rise to 4.5%.

Considering a cooling labor market, the 2025 median dot plot slightly tilts to the dovish side with a split 10-9 vote. Two more 25 basis point rate cuts are expected this year, bringing the year-end median implied rate down to 3.6% from 3.9% in June.

The median dot plot further sees just one cut in 2026 for a terminal rate of 3.4% (vs. 3.6% in June), and one cut in 2027 for a terminal rate of 3.1% (vs. 3.4% in June). The median longer-run dot remains unchanged from the June projection at 3.0%. That said, there is a wide dispersion among projections, highlighting the uncertainty in the outlook.

Policy outlook

It was well anticipated that the FOMC would cut rates by 25 bps during today’s meeting. However, the FOMC’s acknowledgment of higher downside risks in employment reinforced the likelihood of two more cuts in 2025. Chairman Powell’s evaluation of the labor market was measured against inflation considerations, as the tariff-induced impact remains highly uncertain and difficult to forecast.

Looking ahead, it’s clear that the slowdown in labor demand, despite Powell’s acknowledgement that shrinking supply has kept the labor market in a “curious” balance, will likely keep the Fed’s focus on employment developments. The economic picture, while slowing, remains not as challenging as in the past, and the Fed seems to be not overly concerned about the outlook.

Amid ongoing uncertainty in tariff policy, the Fed will need to navigate mixed labor market signals while evaluating any potential upside inflation risks. For now, today’s 25 basis point cut has allowed the Fed to respond ahead of any further deterioration in the labor market and give some relief to the more vulnerable areas of the economy.