Fed rate cut reaction with GianLuigi Mandruzzato and Stefan Gerlach

Welcome to Beyond the Benchmark, the EFG podcast with Moz Afzal.

GianLuigi Mandruzzato:

Hello, my name is GianLuigi Mandruzzato, senior Economist at EFG. I'm standing here in for our Chief Investment Officer, Moz Afzal. We will comment on the Federal Reserve decision, which has just cut interest rates by 0.25% or 25 basis points. The Federal Reserve, unlike other central banks, sets a range for the federal funds rate and after today's reduction, the new range is between four and four and a quarter percent. With me is EFG's chief economist Stefan Gerlach. And we'll ask Stefan, what do you make of the Fed decision?

Stefan Gerlach:

Thanks very much, GianLuigi. Well, I think this is pretty much what everybody expected. Market had priced in at 25 basis points cut with the probability of something like 95%. So I think this was exactly what everybody expected.

GianLuigi Mandruzzato:

So the Fed noted that downside risks to employment have risen even though inflation has moved up. What do you think this means for the future monetary policy decisions?

Stefan Gerlach:

So the way Chairman Powell presented this is the downside risks to the labour market had picked up and there is of course some upward pressure on inflation coming from tariffs. But in the big scheme of things, the Fed now attached more weight to the downside risks to the labour market than to inflation pressures. So I think this means that the Fed is now watching out for what's going to happen in the labour market and that is their source of concern and exactly what happens in the future will of course depend on how the data comes in in the future. And that's simply too early for us to guess.

GianLuigi Mandruzzato:

Well, as always, there is a range of views within the Federal Reserve. Was this decision tonight unanimous?

Stefan Gerlach:

I think everybody agreed except Stephen Miran, he wanted to have a cut by 50 basis points, but everybody else agreed, and I think that's probably about as well as one can expect this to work out in the current situation. There had been speculation that perhaps the Fed, the FOMC was split into three groups, that didn't happen. So I think this was as good as it gets.

GianLuigi Mandruzzato:

And do you think that Miran, which was just attending, his first FOMC just being nominated by President Trump, do you think that his views will affect more political pressure from the White House than an outright assessment of what is needed from monetary policy?

Stefan Gerlach:

If you look at these dot plots, so the members of the FOMC they give their views four times a year about what interest rates they think they will have to set at the end of this year, next year and the year after in order to reach their statutory requirements. Now if you look at those then you will see that next year it's sort of again, a cloud of these points. So perhaps he feels that rates could be a little bit lower and was a little bit keener to cut rates quickly now, but it doesn't look like his views are very different from those as far as we can tell from those of the other members. So I think if anything, it probably just reflects a sense that the Fed can afford to cut a little bit faster now than any very different views about what the level of interest rates should be.

GianLuigi Mandruzzato:

Finally, I would point to the risk of tariffs affecting the inflation rate. Power commented during the press conference and acknowledged that there is indeed some pass through, but that seems so far contained. What should we be concerned about for the next few months and how that could affect the Federal Reserve decision on interest?

Stefan Gerlach:

So Powell effectively said that there are two forces acting on the inflation rate right now. On the one hand we have the tariffs and they tend to push up goods prices, although by less I think, than he and the other FOMC members had expected. On the other side other parts of the CPI in particular services inflation rate for those components are weaker. Putting on downside pressures on inflation. I was quite struck by the fact that the projections, the median projection for PCE inflation for this year was just 3%. Next year the median projection is for 2.6% inflation and for 2027 for inflation of 2.1%. So that suggests to me that the FOMC does not now expect very much inflation and to the extent there is some inflation, it'll be temporary and just for 2025. So to me that means that the FOMC thinks that the increase in inflation will be quite moderate in fact, and also temporary.

And of course if you take away the risks of a pronounced and perhaps protracted increase in inflation, if you do no longer think that will happen, then of course you will be more concerned about the labour market. So I think this is a rebalancing of risks and of course that will impact on the outlook for monetary policy. As Chair Powell said, the FOMC members, if you look at their projections, they basically think interest rates will be 25 basis points lower this year, next year, and the year after. If you compare to the projections that they announced or revealed I should say in June. So this is a cut to deal with the risks of the labour markets and it comes following a recognition by the FOMC or a belief by the FOMC that the inflationary consequences of the tariffs will not be as great as many people fear they will be and they will not be as persistent either.

GianLuigi Mandruzzato:

Okay, thank you very much Stefan. It was great chatting with you about the Fed decision and I look forward to having other chats in the future.

Stefan Gerlach:

Thank you very much. It's always fun to talk about these monetary policy decision just as they happen before one has time to see how markets react and how other commentators react. So yeah, it was fun. Thanks very much.

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