The Fed’s Next Moves After Mixed Data

17 snips

Aug 20, 2025

The podcast dives into recent economic data and how it shapes the Federal Reserve's next moves. A surprise rise in services inflation, driven by increased airfares and hotel prices, indicates that inflation might remain above target. It also discusses the implications of rising tariff rates on prices and labor market influences affecting global central bank strategies. Overall, the outlook suggests a cautious approach from the Fed, maintaining the current interest rates amid mixed economic signals.

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INSIGHT

Tariffs Could Keep Inflation Elevated

Tariff implementation delays mean their full price effects may be lagged and push goods inflation higher.
Services disinflation won't fully offset rising goods inflation, leaving inflation above the Fed's target.

INSIGHT

Services Inflation Reversed In July

Services inflation unexpectedly reversed with airfares and hotel prices rising after prior deflation.
Core CPI and core PCE remain at last year's pace, limiting room for weaker goods data to offset services.

ADVICE

Watch August Jobs Before September Decision

Monitor August jobs and unemployment closely to gauge whether the Fed will stay on hold in September.
If payrolls accelerate and unemployment stays ~4.2–4.3%, the Fed may look through earlier weak prints.

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Markets have already priced in a Fed cut, given the mixed economic data in the July labor and CPI prints. Our Global Economist Arunima Sinha makes the case for why we’re standing by our baseline call for a higher bar for a rate cut.

Read more insights from Morgan Stanley.

----- Transcript -----

Arunima Sinha: Welcome to Thoughts on the Market. I'm Arunima Sinha, Global Economist at Morgan Stanley.

Today – our evaluation of the Fed's policy path following the July CPI print, and the broader implications for other central banks.

It's Wednesday, August 20th at 2pm in New York.

Our baseline call has been that the Fed will remain on hold this year, and last week’s CPI print has not changed that view. As we have noted, average tariff rates are still ramping up given the implementation delays, and so their cumulative effect on prices could be more lagged. Within the CPI print, tariff exposed goods other than apparel and autos continued to be firm. The surprise came in services inflation, which showed a reversal led by the uptick in airfares and hotel prices, which had been running in deflationary territory for much of this year.

Some of the pushback against our view on inflation stepping up over the summer due to tariffs was that services disinflation could compensate. But as this print showed, that is unlikely to be the case. While we expect services inflation to continue to moderate, we think that services disinflation in the first half of [20]25 was exaggerated by weakness and volatile competence; and both core CPI and core PCE inflation are still at their pace from last year.

So further acceleration in goods inflation from tariff effects over the summer would still see inflation remaining well above the Fed's target. After the July U.S. employment and CPI reports, the bar for the Fed to stay on hold in September is clearly higher.

So, what are the risks to our call?

The road goes back to how the data and the Fed's reaction function will evolve over ahead of the September meeting. The August jobs report will be important. If it is a solid employment report, with a sequential acceleration in payrolls and the unemployment rate around 4.2 to 4.3 percent, then the Fed could likely look through the weakness in the May and June prints – attributing the slowdown to the uncertainty following Liberation Day and not representative of the underlying trend.

If, however, there were to be a sharp drop off in the hiring pace, which is currently not being indicated by other job market indicators such as jolts or claims, then the Fed could take the view that the labor market is much weaker than anticipated and restart easing. There is also the possibility of a cut from a risk management perspective.

Even with inflation running well above target, the Fed could take the July employment report as a clear signal of downside risk to the labor market and start the easing cycle. Messaging from Fed officials has so far been mixed, with some taking signal from the jobs data and others remaining less worried with the unemployment rate remaining low.

Outside the U.S., central bank trajectories remain tightly linked to both the Fed's path and the evolving U.S. growth outlook. Recent labor market data have introduced downside risks to our ECB and BoJ calls.

In Europe, if Euro strength persists and U.S. recession risks rise, our euro area economists see a reduced risk to their September easing baseline. In Japan, the Bank of Japan remains cautious. Stronger U.S. data could tilt the balance toward a rate hike later this year – though October remains a high hurdle, making December or beyond more plausible. That said, if the U.S. economy slows in line with our forecast, the likelihood of further BoJ tightening diminishes reinforcing our base case – the BoJ staying on hold through end of 2026.

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