To cut or not to cut? This week's inflation data complicates the picture for the Fed

[The Federal Reserve ( FED ) to control interest rates. Wooden blocks FED on coins with USA flag background. American economy and business. Federal Reserve Bank Interest rates rise policy. FED concept.]
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At the start of the month, a significantly weaker than expected July nonfarm payrolls report along with one of the biggest two-month revisions in decades to job growth all but convinced market participants that the data would be enough to finally get the Federal Reserve to cut interest rates.

However, this week's inflation data further complicates things for the Fed. The central bank's famous dual mandate is to ensure price stability and maximum employment. With the labor market showing signs of cracking and inflation data starting to heat up, adhering to that dual mandate has become more difficult.

"The inflation data released this week illustrate the challenges the Fed faces in its efforts to balance its dual mandate. The labor market is showing signs of lost momentum, but inflation is still above the 2% target and drifting in the wrong direction. Our current forecast for the fed funds rate looks for the FOMC to cut 25 bps at its September, October and December meetings," Wells Fargo said in its weekly economic and financial commentary on Friday.

Immense political pressure to cut interest rates is also probably not helping. U.S. President Donald Trump has continuously criticized the Fed and chair Jerome Powell for not easing monetary policy. Meanwhile, not all Fed officials are convinced that rate cuts are warranted.

"Currently, the relatively moderate pace of demand growth and the cooling labor market are working against the passthrough of tariffs to inflation," Kansas City Fed President Jeffrey Schmid said in a speech on August 12. Schmid had voted to keep the key policy rate steady in July.

"Today, the Fed cannot offset the effect of higher tariffs on prices, but what the Fed can do is monitor demand growth, provide space for the economy to adjust, and keep inflation on a path to 2 percent. Overall, I am anticipating a relatively muted effect of tariffs on inflation, but I view that as a sign that policy is appropriately calibrated rather than a sign that the policy rate should be cut," Schmid added.

JPMorgan's Michael Feroli believes that if the next Fed monetary policy committee meeting were to take place next week instead of in September, there would still be a case for cutting rates.

However, "the data released this past week would have made that a more awkward and uncomfortable cut for many on the Committee," Feroli said on Friday.

Investors will be looking for further clues on the Fed's thinking at the annual Jackson Hole Economic Policy Symposium from August 21 to 23.

"While highly anticipated, it is useful to recall that several recent Jackson Hole speeches by Fed chairs did not break new ground or send clear policy signals. Despite this week’s data, we still see the FOMC cutting at the next meeting," Feroli said.

"So, to the extent Powell does talk about the policy outlook next week, we see him noting the softer July jobs report as tilting some of the employment-inflation risk balance. However, with several Fed speakers recently stating that the case for a cut has not been made, and with more employment data to come, we don’t think Powell can firmly guide toward easing at the next meeting," he added.

According to the CME FedWatch tool, traders are currently expecting a 25 basis point rate cut by the central bank in September.

Wall Street this week posted solid gains, partly on expectations for Fed rate cuts. Here are some exchange-traded funds that track the benchmark S&P 500 index (SP500 [https://seekingalpha.com/symbol/SP500]): (NYSEARCA:SPY [https://seekingalpha.com/symbol/SPY]), (NYSEARCA:VOO [https://seekingalpha.com/symbol/VOO]), (NYSEARCA:IVV [https://seekingalpha.com/symbol/IVV]), (NYSEARCA:RSP [https://seekingalpha.com/symbol/RSP]), (NYSEARCA:SSO [https://seekingalpha.com/symbol/SSO]), (NYSEARCA:UPRO [https://seekingalpha.com/symbol/UPRO]), (NYSEARCA:SH [https://seekingalpha.com/symbol/SH]), (NYSEARCA:SDS [https://seekingalpha.com/symbol/SDS]), and (NYSEARCA:SPXU [https://seekingalpha.com/symbol/SPXU]).

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