Next week is going to be big. Why, you ask? I know some of you must be thinking about the Federal Reserve board meeting, wondering whether they will cut rates and by how much? This undoubtedly will make headlines (and already has); however, unless they go for the highly unexpected 1/2 point rate cut, the news is likely already completely priced into financial markets. However, this is not the only reason why next week is a big week. More importantly than the interest rate decision, I’m turning 40 next week. And while age is just a number (that’s what everyone says, right?), there is a small sense that you’d better enjoy your family, friends, and activities because you never know how long you’ll have. But reflecting on big milestones often involves weighing challenging choices, which is actually a perfect segue back to the Fed’s current predicament.
The Fed currently finds itself in a difficult situation. The labor market is showing real signs of weakness, yet inflation is back on the rise. The dual mandate of stable prices and full employment is, therefore, at odds with itself. And this is why the voting members find themselves between a rock and a hard place. Lowering rates is generally beneficial for economic activity, which in turn would be favorable for the labor market; however, this same action also tends to increase inflation. But if they don’t do anything (or too little), they risk letting a labor slowdown escalate into something much larger. So let’s take a look at a few charts that will help highlight the predicament.
The Case for a Cut
We’ll start with the labor market, as that is the only reason for cutting rates at the moment. The first chart illustrates the steady decline in average job creation over the past three years. Each column represents monthly job creation, while the three horizontal lines indicate the average monthly change for each year. While the monthly numbers are somewhat erratic, the annual averages clearly illustrate the situation: job growth has been declining and is dropping to levels that are less than healthy.
Next, we’ll move to a much longer-term chart, which has data back to the late 1930s. The line chart here utilizes the same underlying data as the chart above; however, it is showing the year-over-year percentage change in monthly Nonfarm payrolls. I know, there’s a lot going on here, but focus on the red line, which is set at the current rate in August 2025 of 0.93%. Then, look at where the red line intersects the blue line throughout history. Notice that below this level of 1% growth, the economy was either in a recession or entering a recession on all but one occasion. This is likely weighing heavily on the Fed.
The Case for a Pause
Moving to inflation, unfortunately, the story doesn’t quite seem to support material rate cuts. You can see in the first chart below that inflation has been increasing since April (coincidentally, or not, aligned with the start of the tariff plan) and is returning to levels we first reached in mid-2024. Interestingly, if you focus on the components, Shelter, which has a significant weight in the CPI calculation, has been steadily declining since early 2023, as many expected. However, it’s the other pieces of core goods and food/energy that have risen over the last five months. And it is those two items that are likely being impacted, at least in part, by the new tariffs.
Finally, as we examine the last chart, we will see some of the specific areas that have moved the most over the past three months. It specifically shows the annualized 3-month change of select items within CPI, meaning if the items continued to grow at the same rate they did over the last three months for an entire year, this is what the number would be. As you can see, there are some startling numbers, with coffee and beef increasing by 38% and 28%, respectively. You’d better watch out if you like Starbucks or hamburgers. On the other hand, eggs have declined by over a third, which is a welcome sight for many families. And if anyone eats cereal like they are still eight years old (like me), good news for you too, because prices are down there as well.
Between a Rock and a Hard Place
Putting everything together, like we said at the outset, the Fed is not in an enviable position. If they cut rates to help turn the labor market around, it’s very possible that inflation could move in the wrong direction. However, if they sit on their hands and hold rates steady, we may steady the inflation growth, but at the cost of a further decline in the labor market. This reveals a level of nuance often lost in the headline debates or by pundits on TV. So, while next week will be big for me (kind of), it’s definitely much bigger for the Fed, the economy, and financial markets. Their ‘gift’ won’t be a simple one; it will be a carefully weighed decision on which risk, a stalling labor market or persistent inflation, is the one worth taking.
Markets / Economy
- Markets moved strongly higher again this week, with an insane +36% single-day move in Oracle on Wednesday. The S&P finished the week up 1.6%, the Nasdaq was up 2.0%, and the small-cap Russell 2000 was up 0.3%.
- The U.S. economy added 911K fewer jobs in the 12 months through March 2025 than initially reported, the largest downward revision since at least 2000, according to the BLS’s preliminary benchmark revision.
- Producer prices in the U.S. unexpectedly fell 0.1% in August, following a downwardly revised 0.7% rise in July, well below forecasts of a 0.3% increase.
- U.S. CPI rose 0.4% in August, up from July’s 0.2% increase and above market expectations of 0.3%. It was the sharpest monthly rise since January, fueling concerns that tariff policies are adding to cost pressures.
Stocks
- U.S. equities were in positive territory. Technology and Utilities were the top performers, while Consumer Staples and Materials lagged. Growth stocks led value stocks, and large caps beat small caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield decreased three basis points to 4.06% during the week.
- Global bond markets were in positive territory this week.
- Corporate bonds led for the week, followed by government bonds and high-yield bonds.
