Uncontrollable Urge

‍

About Face

‍

Soundbite: We were downplaying concerns over the threats to Fed independence, springing mainly from our hope that a rational “Invisible Hand” would prevail. Bill Dudley, the former president of the New York Fed, brought up the fact that because President Trump could appoint four out of seven Fed Governors, that majority could refuse to extend the terms of all 12 regional Federal Reserve Bank presidents when their terms expire this February. That argument showed us that this administration needs to walk back its talk because it does have a path to stuff the FOMC ballot box, which would strip a layer of credibility in our capital markets. We have confidence that the administration will do the responsible thing before markets show them that actions have consequences.

We had thought that even in the worst-case scenario, the administration would put four FOMC voters who are beholden to the president’s view of drastically lower interest rates. Because there are twelve voters on the FOMC, that meant minimal damage because those four governors would remain a minority. However, Bill Dudley points out a trap door exists: those four governors are a majority on the Federal Reserve’s Board of Governors. That means they have the deciding votes when the Board reviews the 2026 renewal of the five-year terms for the 12 regional presidents.

Dudley’s concern got us to think through the following scenario: what if Kashkari from Minneapolis, Paulson from Philadelphia, Logan from Dallas, and Hammack from Cleveland were not approved to continue their term. All are slated to be 2026 FOMC voters, and if more politically motivated appointees replace them, that would turn four votes into an eight-vote FOMC majority. There could be nine Trump appointees with voting rights on next year’s FOMC if New York Fed President John Williams is added to the mix.

We believe that the potential market reaction at the long end of the yield curve would work at counter-purposes to the administration’s plans to supercharge the economy into the midterms. That alone should keep this nightmare scenario from unfolding. Bill Dudley seems to agree: “Certainly they understand that refusing to reappoint Fed presidents who don’t favor cutting interest rates sharply would be a nuclear option.”

Regardless, it is unsettling to think this is even possible. If there is continued rhetoric about a shootout at the Fed Corral, the prospects of higher long-term rates and increased chances of a debt downgrade will create significant market uncertainty and illiquidity, similar to that seen last April. For now, investors have faith that Washington knows when not to skirt boundaries.

‍

Dallas Buyers Club

‍

Soundbite: Today’s July PCE Price index showed inflation was in line with expectations, but Market-based Core and Supercore moved up. Those two components are closely watched by the FOMC, and their downturn has been behind many Committee members pushing for lower rates in September. The reversal in both is not sufficient to reverse course, but if there are other inflation surprises in PPI and CPI before the September FOMC meeting, today’s inflation data will support an argument for unchanged rates. We had expected additional detail out of the Dallas Fed, but it has been delayed. June’s report showed an alarming increase to 30% of the inputs into the PCE Index that have been rising by more than 5%. We wanted to see the July data, as will the FOMC voters.  

The latest Personal Consumption Expenditure Price Index did nothing to move any Federal Open Market Committee (FOMC) voter toward an unchanged rate decision, but it certainly will not convince anyone that inflation is moving lower. Services inflation ex-housing was mentioned by New York Fed President John Williams this week as something he is watching carefully, and we agree, because ex-Energy and Housing Services PCE was 3.4% in December 2022 and is 3.3% for the most recent July 2025 reading, showing little signs of moving toward the Fed’s two percent inflation target. Overall services inflation was 9.3% in December 2022 and is 5.3% in July, a significant drop, but still extremely high.

Governor Chris Waller came out last night in a speech titled “Let’s Get on with It,” calling for a 25-basis point cut at the September 16-17 FOMC meeting. Waller prefers actual observed inflation data, not imputed statistics that use estimates or surveys; a favored inflation gauge is the Market-based Core PCE series. While one can argue that it is not rising too much, it did tick up for a fourth consecutive month to a one-year high.

Governor Waller’s mind is made up, as he is convinced that tariffs will be a one-time increase split equally between exporters, retailers, and consumers. However, others on the Committee could look at Core Services ex-Housing (“supercore” inflation) and Market-based Core as continued evidence of inflation uncertainty. The distribution of PCE components calculated by the Dallas Fed will also be a crucial piece of information. Stay tuned for that, as well as the upcoming PPI and CPI reports, out on September 10 and 11.

‍

Just in Time

‍

Soundbite: New York Fed President John Williams increased the odds for the possibility of no change in rates at the September Federal Open Market Committee (FOMC) meeting. On Wednesday, Williams aligned himself with Chair Powell’s Jackson Hole comment that he views monetary policy as just “moderately restrictive.” He mentioned that services inflation excluding housing as sticky and referred to the labor markets as solid. With the influence Williams carries among FOMC voters, his alignment with Powell makes the upcoming employment and inflation numbers extremely significant.

Over the years, John Williams’ policy views have been closely aligned with Chair Powell's. Therefore, we thought it was important that he suggested he was in no hurry to lower rates: “At some point, we need to move interest rates…down over time.” Given that Williams and Powell move in lockstep, it supported our view that Powell’s Jackson Hole speech about a shift in the balance of risks due to labor market weakness reflected the Committee’s overall beliefs rather than his own. The head of the New York Fed repeated Powell’s description that “monetary policy is modestly restrictive,” adding that the labor market is still solid, despite the downward payroll revisions in May and June. Williams added that the slowdown in hiring growth was a function of shrinking labor supply and pointed to robust wage growth as another sign the job market was solid.

Because he considers September a “live meeting” meaning a rate cut is in play, and that there could be “a couple of rate cuts and [policy will] still be modestly restrictive” we would not be surprised if he votes for a 25-basis point cut. However, the historical connection between Williams and Powell, plus the influence Williams carries among his voting colleagues, could swing the rate decision toward unchanged. That potential puts significant weight on the upcoming PPI and CPI reports, and of course, Friday’s payroll data. If the employment population ratio continues to fall when nonfarm payrolls are released, then we believe a 25-basis point cut is a lock, but certainly, Williams has left the door open for an unchanged rate decision.

‍

What to Look for This Week

(All times E.S.T.)

‍

1. Friday, September 5 at 8:30 a.m. August Non Farm Payrolls for August. Government Payrolls are expected to contract by 25,000 with Private Payrolls up 75,000 for a headline number of 50,000. There may be more static coming from education payroll revisions. Our focus is on the Employment-Population ratio, because any more of a drop would be a warning for the jobs market. We will be looking to see whether Residential Building Construction starts a more appreciable downturn.

2. Wednesday, September 3 at 10:00 a.m. Jobs and Labor Turnover Survey for July (always lagged one month). The JOLTS Hires Rate is key here: it fell to 3.2%, the lowest level in a year, and the lowest over the last decade was the April 2020 pandemic related pullback of 3.1%. Any drop will be of concern, and lower expectations for Friday’s employment data.

3. Thursday, September 4 at 10:00 a.m. The Non-Manufacturing ISM Report on Business for August Services PMI. The July Purchasing Managers Index at 50.1 just missed dropping into contraction territory, and August is forecast at 49.8. The key data will be the Prices subcomponent, which rose to the highest level since Q4 2022 at 69.1 in July. Tuesday September 2 at 10:00 a.m. is August Manufacturing PMI data. The Employment subcomponent is important because it is at post-pandemic lows as of July.

FOMC Voters Speaking: Wednesday, September 3 at 9:00 a.m. St. Louis Fed President Alberto Musalem speaks on the Economy and Policy. Thursday, September 4 at 11:30 a.m. Fed Governor John Williams speaks on the same topic. Later that day, Chicago Fed President Austan Goolsbee speaks in a moderated Q&A. Goolsbee mentioned after Powell’s Jackson Hole speech that he is still concerned about inflation.

Earnings: Tail end with only 77 companies scheduled to report for the entire week: Thursday, September 4 Broadcom AVGO has doubled since the April 7 lows reports after market close. Wednesday September 3, Dollar Tree DLTR will report if people are still moving to discount retailers before market close and Salesforce CRM after market close.

‍