Points | FOMC - Degrees of Freedom (July 2025)
- Edward von der Schmidt
- Aug 3, 2025
- 20 min read
Without committing to a preset course, the Federal Reserve signaled that it will consider adjusting policy at the September meeting after holding in July. Whether a majority will choose to ease and lower rates will depend on participants' views of labor markets and the inflation outlook at that time. The Fed has characterized employment as at or near maximum and inflation as somewhat above target, which together have called for a modestly restrictive stance (i.e., above-neutral rates). Labor market deterioration or meaningful disinflation could spur a more balanced if not accommodative posture to support the real economy. Accelerating inflation or more persistent trade concerns in the absence of realized employment weakness could convince the Committee to bide their time and reassess in October. Distinct from their recent holding pattern, however, the FOMC will be prepared to adjust - as appears more likely than not in September. Weighing tariff clarity and economic resilience, they may also choose to wait a bit longer instead. A rate cut is very possible but not at all guaranteed and will depend on the perceived balance of risks.
3 AUG 2025
EDWARD VON DER SCHMIDT
| Sources
Key Takeaways
The Federal Open Markets Committee decided to hold the federal funds rate target range at 4.25-4.50%. The largely unchanged meeting statement noted economic growth had "moderated" and brought two dissents in favor of beginning to normalize policy. The majority of participants preferred to wait and reassess at the next meeting on September 16-17.
As of the July 29-30 meeting, labor markets were still characterized as "solid". Meanwhile, the composition of above-target inflation has shifted from services to core goods even as consumer spending has lost momentum. Trade policy continues to evolve and tariff-driven inflation is relatively nascent. While "one-off" price increases may be a "reasonable base case", the possibility of greater disruptions and a more persistent inflation problem cannot be discarded. The latter risk must be "assessed and managed".
With employment currently at target and inflation above it, the Committee argued that modestly restrictive policy was still warranted in the absence of realized labor market weakness and given elevated uncertainty. Chair Powell emphasized that a more balanced risk profile would call for more more neutral (i.e., less restrictive) monetary policy, adding that "the next steps that we take are likely to be in that direction". For now, the Fed intends to guard against a known issue - inflation - while preserving the flexibility to adjust quickly to developing risks.
Although they voted to hold off in July, the entire Committee deliberated the appropriate time to resume policy normalization and begin easing. The arguments for and against cutting rates have been made in earnest, establishing the criteria to adjust policy and clearing the way for a 'live' meeting in September. Will risks have evolved in such a way as to warrant a change in position?
The Committee is already inclined to ease. Their stated challenge is to do so efficiently by timing their adjustments appropriately. Cut too quickly and progress on inflation may be undone, potentially leading to higher policy rates down the road and a more severe economic downturn as a consequence. Cut too late and restrictive policy rates may do more harm to the labor market than necessary. The reason the Fed will not explicitly commit to cutting next month is because they cannot know the balance of risks that they must assess in advance, particularly in such a dynamic environment.
The Fed is fully prepared to cut rates as soon as September. Will they? Two assumptions underpin their recent assessments: solid labor markets and one-off tariff inflation. A "totality" of data reflecting labor market weakness (including higher unemployment rates) would alter the perception of outlook risks and favor a more balanced policy stance - if not outright accommodation. The two dissenting voters argued for a gradual start to normalization (read 25bp) toward somewhat lower neutral rates, but the Fed has shown it will go bigger (50bp or more) if threats to employment are pressing enough. Recent payroll revisions are cause for concern but not entirely unanticipated, either.
On the other hand, price stability is today's concern and carries the (diminished) risk of becoming an even bigger problem. As long as labor markets can at least tread water, the Fed may have sufficient cover to lean on inflation for a bit longer to ensure that a temporary supply shock does not undo years of progress or undermine hard-won and difficult-to-rebuild inflation-fighting credibility. Given the relatively slow transmission of tariff effects to date, the majority would prefer to remain patient if possible.
The Fed knows that it may find itself caught between competing inflation and employment mandates. According to their soon-to-be-revised consensus statement, whichever goal is further from target and will take longer to resolve will determine the thrust of policy. For the time being, the Fed has chosen to maximize its freedom to respond - or wait. A minimum 25bp cut may appear likely today, but a lot can change in six weeks' time. In Powell's words, "We'll just have to see."
Statement Comparison
Topic | June | July |
Economic Activity | "has continued to expand at a solid pace" | "moderated in the first half of the year" |
Labor Market | "conditions remain solid" | "" |
Inflation | "remains somewhat elevated" | "" |
Risks | "The Committee is attentive to the risks to both sides of its dual mandate" | "" |
Economic Outlook | "Uncertainty [...] has diminished but remains elevated" | "Uncertainty [...] remains elevated" |
Additions:
"Although swings in net exports continue to affect the data, recent indicators suggest that growth of economic activity moderated in the first half of the year."
"Uncertainty about the economic outlook remains elevated."
"Voting against this action were Michelle W. Bowman and Christopher J. Waller, who preferred to lower the target range for the federal funds rate by 1/4 percentage point at this meeting. Absent and not voting was Adriana D. Kugler."
Subtractions:
"Although swings in net exports have affected the data, recent indicators suggest that economic activity has continued to expand at a solid pace."
"Uncertainty about the economic outlook has diminished but remains elevated."
Changes to the statement were limited. The Committee characterized growth as 'moderating' instead of 'expanding at a solid pace' in a nod to slowing activity and consumption. Outlook uncertainty remained elevated in July as it did in June. Nearly all other language was unchanged, including the basic criteria for adjusting policy (i.e., "if risks emerge that could impede the attainment of the Committee's goals"). By preserving a simple statement with limited forward guidance, the Fed is seeking to maintain maximum policy flexibility without prematurely committing to any particular course of action.
Were it not for two dissents in favor of cutting in July, there might have been little in the statement to suggest that the FOMC's predisposition has changed. In many ways it hasn't, though their assessments of risks to price stability and employment invariably will. The Committee is already inclined to lower rates that are admittedly restrictive but is collectively waiting for an 'all-clear' before easing, namely that any tariff-driven inflation will not become a larger, more persistent problem. Both dissenters were confident in the latter assumption, but the majority of the FOMC needed more time and data to evaluate.
Prepared Remarks
"Despite elevated uncertainty, the economy is in a solid position. The unemployment rate remains low, and the labor market is at or near maximum employment. Inflation has been running somewhat above our 2 percent longer-run objective."
"We believe that the current stance of monetary policy leaves us well positioned to respond in a timely way to potential economic developments."
"Recent indicators suggest that growth of economic activity has moderated. [...] The moderation in growth largely reflects a slowdown in consumer spending."
"Overall, a wide set of indicators suggests that conditions in the labor market are broadly in balance and consistent with maximum employment."
"Inflation has eased significantly from its highs in mid-2022 but remains somewhat elevated relative to our 2 percent longer-run goal. [...]"
"These readings are little changed from the beginning of the year, although the underlying composition of price changes has shifted: services inflation has continued to ease, while increased tariffs are pushing up prices in some categories of goods."
"Changes to government policies continue to evolve, and their effects on the economy remain uncertain. Higher tariffs have begun to show through more clearly to prices of some goods, but their overall effects on economic activity and inflation remain to be seen."
"A reasonable base case is that the effects on inflation could be short-lived—reflecting a one-time shift in the price level. But it is also possible that the inflationary effects could instead be more persistent, and that is a risk to be assessed and managed."
"Our obligation is to keep longer-term inflation expectations well anchored and to prevent a one-time increase in the price level from becoming an ongoing inflation problem. [...] We see our current policy stance as appropriate to guard against inflation risks. We are also attentive to risks on the employment side of our mandate."
"In coming months, we will receive a good amount of data that will help inform our assessment of the balance of risks and the appropriate setting of the federal funds rate."
The prepared remarks offer clear if broad context for the Fed's policy stance. In the Committee's view, the economy is still "solid" overall. Despite moderating growth and consumer spending, labor markets have proven resilient over the last year and inflation remains above-target — before considering the impact of tariffs. Although services inflation has eased, goods prices are now moving higher.
The central question for the Fed remains whether goods price inflation induced by tariffs will be temporary or trigger a more lasting process. At present, the central bank views transitory tariff effects as a "reasonable base case" but acknowledges that more persistent inflation is still possible. Trade policy is evolving and its effects are not yet fully known.
For the time being, the Fed has chosen to guard against inflation while being attentive to employment headwinds. Policy clarity and economic data will inform the Fed's assessment of those risks. Greater confidence that inflation will not be an ongoing problem or sufficient evidence of labor market weakness will support a case for normalization or even accommodation.
Otherwise, the FOMC appears willing to maintain the status quo as long as they believe they can afford to. The Fed has greater control over inflation and right now views price stability as a more pressing issue. Any rapid deterioration in the real economy could change that calculus — provided that the inflation outlook does not materially worsen in tandem.
Press Conference
Chair Powell offers many important insights and clarifications that are worth considering in context. Watching this press conference or reading a full transcript will be very helpful.
Current Policy Stance:
"So, as you know, today we decided to leave our policy rate where it's been, which [...] I would characterize as modestly restrictive. Inflation is running a bit above 2% as I mentioned, even excluding tariff effects. The labor market is solid, historically low unemployment, financial conditions are accommodative and the economy is not performing as though restrictive policy were holding it back inappropriately. So it seems to me and to almost the whole committee that the economy is not performing as though a restrictive policy is holding it back inappropriately and modestly restrictive policy seems appropriate."
"All that said, there's also downside risk to the labor market. In coming months we will receive a good amount of data that will help inform our assessment of the balance of risks and the appropriate setting of the federal funds rate."
...
"Our two mandate variables, right, are inflation and maximum unemployment. Stable prices and maximum employment, not so much growth. So the labor market looks solid, inflation is above target, and even if you look through the tariff effects, we think it's still a bit above target. And that's why our stance is where it is."
Debate:
"So, on the dissents, what you want from everybody and also from a dissenter is a clear explanation of what your thinking is and what are the arguments you're making. We had that today. Basically this was quite a good meeting all around the table where people thought carefully about this and put their positions out there."
"As I mentioned, you know, the majority of the Committee was of the view that inflation is a bit above target, maximum employment is at target. That calls for modestly restrictive, in my way of thinking, modestly restrictive stance of policy for now [emphasis added]. We had two dissenters, and we want that expression of your thinking. We we certainly had that today. I think all around the table."
...
"The discussion around policy was the majority view was still what it has been, which is that inflation is running above target, maximum employment is right at target. That means policy should be a little bit restrictive, somewhat restrictive because we want inflation to move all the way back to its target. So, that's where people have been and still are. Two of our members felt that the time had come to cut and for the reasons that they are going to express. I won't tell you the reasons. They will issue some kind of a thing in the next day or so."
"But that's the story. And I would say, you know, well argued, very thoughtfully argued all around the table, good arguments and it's a situation where - unusual situation. The economy is in you know good shape. But it's an unusual situation where you have risks to both your employment mandate and your inflation mandate. That's the nature of a supply shock. And it's probably not surprising that there would be differences and different perspectives on that, as well as different views of where the neutral rate is - so different views of how tight policy is."
September FOMC:
"We have made no decisions about September. We don't do that in advance. We will be taking that information into consideration and all the other information we get as we make our decision at the September meeting"
...
"I will just say that we haven't made decisions about September. We'll be monitoring all of the incoming data and asking ourselves whether the federal funds rate is in the right place."
...
[Q: If the data stays in line with where it is now then you wouldn't be comfortable cutting in September?]
"I'm not going to say that, no. I just think we are going to need to see the data and it can go in many different directions. The inflation data and the employment data. And we are going to make a judgment based on all of the data and based on that balance of risks analysis that I mentioned."
Future Policy Considerations:
"We're going to be - at some point when we return to moving toward a more neutral stance we will be making that judgment as we go. I don't think we have a preset course. It's not so mechanical as saying we have derived with great confidence the neutral rate and that is our destination. Because really, we understand, no one actually knows what the neutral rate is. We know it by its works. And that will be the way the economy will react over time to slightly looser policy."
...
"a reasonable base case is that these are one-time price effects. Of course, in the end, there will not be - this will not turn out to be inflation because we will make sure that it's not. We will through our tools make sure this does not move from being a one-time price increase to serious inflation."
"We want to do that efficiently, though, efficiently, and that means we want to do it, if you move too soon, you wind up maybe not getting inflation all the way fixed and you have to come back. That's inefficient. If you move too late you might do unnecessary damage to the labor market."
"So, there won't be in the end a big inflationary problem. What we are trying to do is accomplish that in a way that is efficient. But in the end, there should be no doubt that we will do what we need to do to keep inflation under control. Ideally we do it efficiently."
...
"I mean ultimately it's -- it could be any of those things, right? But, you know, if you saw that the risks to the two goals were moving into balance, if they were fully in balance, that would imply that you should move toward a more neutral stance on policy. This is the special situation we are in, which is we have two-sided risks, risks to both of our goals. When we paused, inflation was above target and the labor market was pretty good. So, you know, that was a time when policy -- policy was restrictive when we paused and to be restrictive is to be supporting a return to our inflation target, right. So as the two targets get back into balance, you would think you would move it in a way closer to neutral and the next steps that we take are likely to be in that direction."
"What will it take? You know, it will just -- it will be the totality of the evidence. As I mentioned, there's quite a lot of data coming in which before the next meeting, will it be dispositive of that? You know, it's really hard to say. We don't make those decisions right now. So, we will have to see."
...
"I think we will look at everything. You know, it's -- as I mentioned, you know, a pretty reasonable base case is that this will be a one-time price increase. And in the end, we will make sure that that's the case. We are just trying to do that efficiently. And efficiently means getting the timing right. And if we cut rates too soon, maybe we didn't finish the job with inflation, history is dotted with examples of that, if you cut too late, then maybe you are doing unnecessary damage to the labor market. So, we are trying to get that timing right. And that's effectively what we are doing."
...
"That's why we think policy should be restrictive is because, you know, inflation is above target. When we have risks to both goals, one of them is farther away from goal than the other and that's inflation. Maximum employment at goal. That means policy should be tight because tight policy is what brings inflation down."
"If you came to the view that the risks of the two were more in balance, that would imply that policy shouldn't be restrictive. It should be more neutral - more, more - a neutral stance. And that would be somewhat lower than where we are now - no one knows exactly where that is. That's the framework I think I'd be taking."
...
"And, again, trying to do the right thing in what is a challenging situation because you are being pulled in two directions and you have to decide [...] and actually at some point if they are sort of equally at risk then you really want to be at a neutral policy stance which we are not right now."
Tariff Clarity:
"You are right, it's been a very dynamic time for these trade negotiations, and lots and lots of events in the intermeeting period. But we are still a ways away from seeing where things settle down. We are getting clearly more and more information and you know I think at this point people's estimates, our estimates, outside estimates of the likely, you know, effective level of tariffs is not moving around that much at this point. But at the same time, there are many, many uncertainties left to resolve. So, yes, we are learning more and more. It doesn't feel like we are very close to the end of that process. And that's not for us to judge, but it feels like there's much more to come as well, looking ahead."
...
"And the evidence seems to be mostly not paid -- but paid only to a small extent through exporters lowering their price and companies or retailers, sort of, people who are upstream, institutions that are upstream from the consumer are paying most of this for now. Consumers, it's starting to show up in consumer prices, as you know, in the June report, we expect to see more of that. And we know from surveys that companies feel that they have every intention of putting this through to the consumer. But, you know, the truth is, they may not be able to in many cases."
"So, I think it's -- we are just going to have to watch and learn empirically how much of this and over what period of time. I think we have learned that the process will probably be slower than expected at the beginning. But we never expected it to be fast. And we think we have a long way to go to really understand exactly how we will be."
...
"What we see now is, basically, the very beginnings of whatever the effects turn out to be on goods inflation. And, you know, I will say again, they may be less than people estimate or more than people estimate. They are not going to be zero. Consumers will pay some of this. Businesses will pay some of this. Retailers will pay some of this. But, you know, we are just going to have to see it through."
Growth and Labor Markets:
"The GDP and PDFP numbers came in pretty much right where we expected them to come in. You got to look at the whole picture. [...] if you look at the labor market, what you see is by many, many statistics, the labor market is kind of still in balance. It's things like quits, you know, job openings, and let alone the unemployment rate, they are all very, by many measures, very similar to where they were a year ago. So you do not see weakening in the labor market."
"You do see a slowing in job creation but also a slowing in the supply of workers. So, you have got a labor market that's in balance, albeit partially because both demand and supply for workers is coming down at the same pace and that's why the unemployment rate has remained roughly stable, which is why I said we do see downside risk in the labor market [...] downside risks to the labor market are certainly apparent."
"The main number you have to look at now is the unemployment rate. It's true that the demand for workers in the form of, let's call it just say payroll jobs, that number has come down but so has the break even number in tandem. So you know as long as -- that puts the labor market in balance. The fact that it's getting into balance due to declines in both -- in supply and demand, though, I think does -- it is suggestive of downside risks so we, of course, will be watching that carefully."
...
"We have a very good labor market right now."
...
"Consumer spending had been very, very strong for the last couple of years and repeatedly forecasters, not just us, had been forecasting it would slow down. And now maybe it finally has. [...] Look, it's one of the data points that we pay most careful attention to. And there's no question that it's slowed. And we are watching it closely. But we also watch the labor market and the performance of inflation, those are our two variables that we are assigned to maximize."
...
"I think what we know is that private sector job creation, certainly in the last report, we will see on Friday, but had come down a bit. And if you take the QCEW adjustment seriously, it may be close to zero, but the unemployment rate is still -- was still low. So, what that is telling you is that, you know, demand for workers is slowing but so is the supply. So, that's -- it's in balance, oddly enough. You have got a very low unemployment rate and it's kind of been there for a year as job creation has moved down, but also we know that, you know, because of immigration policy really, the flow into our labor forces is just a great deal slower and those two things have slowed more or less in tandem."
"If you look at things, like I mentioned quits, look at wages, wages are gradually cooling. I look at vacancies to unemployment. Those things have been pretty stable for -- they haven't really moved a lot in a full year. So, I think if you take the totality of the labor market data, you have got a solid labor market."
"But I think you have to see that there are downside risks. It's not -- you don't see weakening in the labor market, but I think you have got downside risks in a world where unemployment is being held down because both demand and supply are declining. I think that's -- it's worth paying close attention to it and we are."
...
"It's going to be the total. Hard to answer that specifically. PDFP I think for the first half private domestic final purchases or final sales as people call it was 1.6 on the first half. GDP I believe was 1.2%. The whole half, you mentioned the quarters. Those are slower. But GDP is bumpy quarter to quarter, half to half and often gets revised, you know, after the fact."
"The labor market data, we still think is -- continue to think is the best data we have on the economy. And that shows a 4.1% unemployment rate. It shows wages, you know, still at a healthy level. But moving ever closer to what we would regard as long-run sustainable consistent with longer-run productivity and 2% inflation. So, the labor market is actually still quite solid."
Inflation:
"Look I think inflation is most of the way back to 2%. There are things like the catch-up inflation, so, for example, all the insurance costs that are now, that are only now going through inflation but they actually reflect inflationary pressures from two, three years ago. So, that's got to go through."
"In addition, now we have three or four tents of inflation in core inflation from tariffs. So, and we can't really separate that out. We are not going to have a separate kind of inflation that isn't the tariffs. We are always going to be dealing with the whole, all of inflation. But the composition as I mentioned has really changed."
"If you go back to the last couple of years, it was all about services inflation, which was being very sticky. Now services inflation is coming down nicely. Goods inflation was well behaved before. And now goods inflation is going up. So, the story has really changed. That's partially because of tariffs. It's also partially because we have restrictive policy in place and we have seen that -- the result of that gradually work its way through the services economy."
...
"Inflation, we were very close to 2%. We are seeing some goods inflation move us away but so far not very far away."
Housing:
"We don't set mortgage rates at the Fed. We set an overnight rate. And the rates that go into mortgages are longer-term rates [...] It's not that we don't have any effect. We do have an effect but we are not the main effect."
"There are other things going on in the housing sector, and one of those is just there's kind of a long-term housing shortage that we have. We haven't built enough housing, this is not something the Fed can help with [...] that will be the case even after things normalize."
"I think the best thing that we can do for housing is to have 2% inflation and maximum employment. And that's what we can contribute to housing."
Government Borrowing Costs:
"We have a mandate and that's maximum employment and price stability. And it is not something we do to consider the cost to the government of our rate changes. We have to be able to look at the goal variables Congress has given us, use the tools they have given us to achieve those goals. And that's what we do."
"We don't consider the fiscal needs of the federal government. No advanced economy central bank does that and it wouldn't be good if we did do that, it would be good neither for our credibility, nor for the credibility of U.S. fiscal policy. So, it's just not something we take into consideration."
Importance of Data:
"I do think, as I have said, I think we are getting the data that we need to do our jobs, and I think it's really important that good data helps, not just the Fed, it helps the government, but also helps the private sector. You know, people in the economy, they use this data a lot, too. So, it's quite important for our economy, and certainly for the Fed's work and other government agencies' work that we continue to get better at data. That's what we have been doing for 100 years, we have been getting better and better and better. It's very hard to accurately capture in realtime the output of a 20 plus trillion dollars economy and the United States has been a leader in that for 100 years and we really need to continue that, in my view."
...
"But we really need -- the government data really is the gold standard in data and we need it to be, you know, to be good and be able to rely on it. And we are not going to be able to substitute for that. But we'll have to make do with what we have. I certainly hope that we get what we need."
Central Bank Independence
"I think that having an independent central bank has been an institutional arrangement that has served the public well. And as long as it serves the public well, it should continue and be respected. If it didn't serve the public well, then it wouldn't be something that we should just automatically defend. But what it gives us and other central banks, what it gives you is the ability to make these very challenging decisions that - in ways that are focused on the data and the evolving outlook, the balance of risks and all of things we talk about, and not political factors."
"And so, governments all over the advanced economy world have chosen to put a little bit of distance between direct political control of those decisions and the decisionmakers. So, if you were -- if you were not to have that, that would be a great temptation, of course, to use interest rates to affect elections, for example. And that's something that we don't want to do. So, I think that's pretty widely understood. Certainly it is in Congress. And, I mean, I think it's very important, I'll just say that."
Sources
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