Cooler-than-expected inflation reading keeps Fed on course for a rate cut next week

A fresh reading Friday showing that inflation cooled slightly in September is likely to keep the Federal Reserve on course for another quarter-percentage-point interest rate cut next week amid continued concerns about the job market.

The Consumer Price Index (CPI) clocked in at 3% for the month of September, a tenth of a percent lower than expected, but inching up from the 2.9% rate in August. On a core basis, which excludes volatile food and energy prices and is the preferred Fed measure, inflation also rose by 3% in September, cooling from 3.1% in the prior month. Month-over-month, core inflation rose 0.2% after rising 0.3% in the two preceding months.

"Goods prices are firming again amid tariff pressures, but softer shelter and services readings show progress where it matters most," said Gargi Pal Chaudhuri, Chief Investment and Portfolio Strategist at BlackRock. "The disinflation trend is intact, keeping the Fed on course for a rate cut next week.”

Long-awaited softening in shelter prices is finally starting to become more apparent in CPI, with rents experiencing the smallest monthly increase since March 2021.

CPI, initially slated for release on Oct. 15, was released with a delay despite the government shutdown because the data is required by law for calculating cost-of-living increases for Social Security payments before Nov. 1.

While Fed officials will use this information in their decision on monetary policy next week, they have not received the September jobs report, retail sales, or the Producer Price Index, complicating their decision.

At 3%, inflation is holding at a full percentage point above the central bank’s 2% target. Fed officials have forecasted inflation would end the year at 3.1% before coming back down to 2.6% next year. Those figures would leave inflation above the Fed's goal of 2%, but many policymakers are now more worried about weakness in the job market than prices. The Fed has a dual mandate to maintain stable prices and maximize employment.

Private sector jobs data has shown that the job market deteriorated this fall. Payroll company ADP reported that private payroll employment fell by 32,000 jobs in September, while the Fed's Beige Book, a compilation of anecdotal evidence across the country, also painted a weaker picture of the job market.

"The cooler-than-expected CPI confirms what we’ve seen overall from private data during the government shutdown — little indication that inflation is surging or that the labor market is falling off a cliff. For a Fed focused on prudent “risk management,” that should translate into another rate cut next week, and likely more to follow," Ellen Zentner, Chief Economic Strategist for Morgan Stanley Wealth Management, said in a statement.

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Eyes on employment

Last week Fed Chair Jerome Powell emphasized that "the downside risks to employment appear to have risen" and shifted policymakers' assessment of the balance of risks, even as the government shutdown has delayed the release of the all-important jobs report.

That appeared to imply that another rate cut is possible at the Fed's next meeting next week, even though Powell did say that monetary policy will be set meeting by meeting.

Wilmington Trust chief economist Luke Tilley is more worried that tariffs are weighing on growth and the job market than pushing up inflation. Looking at job data from the BLS from May through August, since September has been delayed on account of the government shutdown, Tilley says total private sector job growth has totaled 157,000 for that four-month period. Healthcare added 249,000 during that time, but all the other private sectors, added together, including manufacturing to construction, retail, information, professional business services and leisure hospitality, were negative 92,000 jobs.

Tilley believes that the slowdown in the job market is due more to softening demand for workers than simply lower immigration. He pointed to company surveys and surveys of CEOs on hiring that say they're hiring enough to retain headcount level or reducing headcount through attrition, which is attributed it to uncertainty about demand, weak demand or softer sales. And he doesn’t expect job growth to reaccelerate.

“The job market is a lagging indicator, and there’s a risk that's going to keep going down and that we've already turned in the economy,” said Tilley. “It's not going to show up in GDP data yet, but if labor is a lagging indicator, then there's that weakness there.”

The central bank cut rates in September for the first time in 2025 and predicted two more cuts for the year, which would mean reductions at meetings next week and early December.

The path of inflation remains uncertain as President Trump's tariffs work their way through the US economy.

Powell said last week that tariffs will likely result in a one-time price increase, but that may not be all at once and may be spread across several quarters, thus showing up as somewhat higher inflation during that period.

He stressed that the Fed will look for assurance that this one-time increase in prices does not become an ongoing inflation problem, which is important for inflation expectations.

Fed governor Chris Waller said last Thursday he is in favor of trimming interest rates by another quarter percentage point at the end of this month, but after that he wants to move cautiously.

Other members of the Fed, from Chicago Fed president Austan Goolsbee to Kansas City Fed president Jeff Schmid and Cleveland Fed president Beth Hammack, have expressed concern about the risk of inflation becoming more long-lasting.

Markets are pricing in a rate cut at the next meeting and the December meeting as a done deal.

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