The subtle rate cut case
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Illustration: Brendan Lynch/Axios
Inflation has firmed up in the last few months, and economic activity held up. The Federal Reserve looks to be about to cut interest rates anyway.
Why it matters: The case for easier money rests on the need to look through that inflation as a one-time jolt — and to assess that there is an underlying softness to consumer activity.
- As the Fed gears up to cut interest rates in less than three weeks, the latest data shows consumer incomes and spending were solid in July as inflation ticked up.
- In effect, the bet of the pro-rate-cut Fed officials is that even if tariffs drive higher prices, it will prove a one-time event — and will simultaneously cause softening in consumer demand and the job market that will work counter to that inflationary surge.
By the numbers: The Personal Consumption Expenditures Price Index, the Fed's go-to inflation gauge, was stable at 2.6% on a year-on-year basis. The core measure, which excludes energy and food costs and is considered a better gauge of underlying inflation, rose 2.9% in the year ended in July, the fourth straight increase.
- Core PCE was running at a 3% annualized pace over the previous three months, up from 2.6% in June.
- Meanwhile, personal income rose 0.4% in July and consumer spending rose 0.5%, pointing to solid underlying activity.
- The new data was enough to push the Atlanta Fed's real-time GDP tracker tool to an estimated 3.5% growth rate in Q3, up from 2.2% before the data.
Yes, but: The case for rate cuts relies not on those headline numbers, but on underwhelming trend growth and the prospect that the job market is slowing rapidly.
- "Looking into the consumer spending details, it is increasingly evident that households are struggling to push through," said EY-Parthenon chief economist Gregory Daco in a note.
- The gains, he noted, are "largely a reflection of wild swings in auto and recreational vehicles," which have flatlined over a longer arc.
What they're saying: "Economic activity has slowed significantly in 2025 from 2024," said Fed governor Christopher Waller — an advocate of rate cuts and a potential nominee to be the next leader of the central bank — in a speech Thursday night.
- "Growth for the first half of the year was 1.2%. Looking ahead, the limited evidence we have is consistent with continued sluggish growth," he said.
- "Tariffs affect the costs and profits of businesses and, to the degree that they raise prices, also affect the real disposable income of consumers. Some businesses will be directly affected by tariffs, but many more will be affected by how tariffs crimp household spending."
- In the job market, he said, "risks are continuing to build."
Of note: "I favored reducing the federal funds rate" at the Fed's July meeting, Waller said, "and subsequent data on the labor market and inflation indicate this was the right call.
- "So, let's get on with it," he said.
