The Fed Walks a Tightrope as Interest Rate Decision Looms
July 30, 2025
- Author
- Jay Pfeifer
Markets and politics are pressuring the Federal Reserve on the eve of its decision on interest rates.
Stubborn inflation is holding at closer to three percent than the Fed’s stated two percent goal, and employment is keeping steady. Both reinforce arguments against a rate reduction, while the White House is exerting unprecedented pressure for a cut. As the Fed’s board of governors prepare to meet this week, Economics Professor Vikram Kumar says, despite the fact that the Fed tamped down inflation without sparking a recession, “the fog of economic uncertainty” clouds the outlook. The impacts of the increased tariffs and ongoing international trade negotiations have yet to fully materialize.
In this Q&A Kumar helps chart the trajectory of the U.S. economy.
How does the current state of inflation and employment square with Federal Reserve goals?
Unfortunately, the situation has not progressed much from our last discussion. Headline inflation was recorded at 2.7% in July, with core inflation at 2.9%. These figures show we are not yet near the Federal Reserve’s target. The unemployment rate has been steady at around 4.1% over the past year, indicating some stability in the job market. However, policy and economic uncertainties continue to cast a fog over future projections.
The U.S. economy has been surprisingly resilient in the face of major market swings and general anxiety over international trade. How does it look from your vantage point?
Financial conditions, as reflected by the Chicago Fed’s National Financial Conditions Index, lean toward the looser side compared to average. Despite some gloomy predictions, a recession has not materialized. Stability in wage growth, after adjusting for inflation, and a low quits rate, suggest no immediate threats are being felt by workers on average. The current inflation rate is quite close to the long-run expected inflation rate at 2.6% at five years out as surveyed by the New York Fed, so the inflation dynamics are quite stable.
However, there are warning signs. In the first quarter of 2025, the size of the American pie actually shrank. The GDP growth rate was negative 0.5%. Issues like tariffs, policy uncertainty, and weakening consumer sentiment insert complex challenges into its decision-making processes.
In addition to balancing inflation and unemployment, the Fed also has to navigate sharply clearer political pressures. How will that affect their decision-making?
Normally, the pressure comes from the markets. That's always going to be there to some extent. And political undercurrents aren’t necessarily new. What is new is that it is coming from the White House very directly. The Federal Reserve probably needs to think more strategically about how to navigate these treacherous shoals of politics. The Fed can more effectively communicate its decisions and allow greater transparency of its non-monetary functions.
The country is best off if the Fed has monetary policy independence. The data is very clear: Countries that have independent central banks over time have superior inflationary and macroeconomic performance.
Given these factors, what is your outlook on future policy shifts by the Federal Reserve?
The Personal Consumption Expenditures price index (PCE) inflation numbers will be out the day after the Fed’s meeting. It is predicted to edge up, so that argues against a rate cut. The slowdown in immigration may bring supply constraints that can raise inflation. Tariffs will likely cause a passing bump in the inflation rate. These factors argue against rate cuts.
On the other hand, the real economy faces headwinds from tariff-induced distortions and the leading indicators are pointing south. The “tariff premium” in the inflation rate is likely temporary and will dissipate. Future growth in productivity will likely be substantial as AI spreads across the economy — and this mitigates inflation. These factors argue for a rate cut.
It’s a tough call, but on balance, my take — no rate cut. Stand still!
