August 19, 2025

QuickTakes

Dueling Fed Mandates

The Fed is required by law to keep inflation low and stable while also maintaining full employment. Achieving that dual mandate isn't always easy. Currently, the labor market is at full employment, but there are a few signs of weakening. Inflation was on track to fall to the Fed's 2.0% inflation target, but has been stuck around 3.0% recently. Some Fed officials believe that Trump's tariffs are only temporarily boosting inflation and that the Fed should ease as soon as possible to avert any further weakening of the labor market. Other Fed officials are opposed to easing until they can be more certain that inflation is declining to 2.0%.

Fed Chair Jerome Powell has sided with the hawks and has been insulted almost daily in recent months by President Donald Trump for not cutting the federal funds rate as Trump demands. On Friday, Powell will speak at the Fed's annual Jackson Hole conference. He will probably remain hawkish because inflation remains elevated. If so, we side with him. Consider the following:

(1) Inflation: purchasing managers surveys. The sum of the national purchasing managers' indexes for manufacturing and non-manufacturing is a good six-month leading indicator of the PPI final demand inflation rate (chart). The former suggests that inflationary pressures have increased and will persist through the end of this year.

(2) Inflation: consumer durable goods. Tariffs undoubtedly have boosted durable goods inflation in both the CPI and PCED (chart). From the mid-1990s through the pandemic lockdowns, durable goods prices usually deflated. They were falling again following the inflation surge of 2022 and 2023. Since the spring, durable goods prices have been rising again as a result of Trump's tariffs.

(3) Inflation: consumer services. While the impact of tariffs on durable goods inflation is likely to be transitory, services inflation remains troublesome. In the past, Powell has focused on the "supercore" inflation rate, which is closer to 3.0% than to the 2.0% that it was before the pandemic.

Several of the service categories in the PCED are still showing inflation rates higher than their pre-pandemic readings (chart).

(4) Unemployment: layoffs. Meanwhile, initial unemployment claims remain low and consistent with the current unemployment rate of 4.2% (chart). This weekly series and the monthly Challenger data on layoffs confirm that employers are holding onto their workers.

(5) Unemployment: duration. The main problem in the labor market currently is that it is hard to find a job, especially for teenagers and recent college graduates (chart). So the duration of unemployment is increasing. Previously, we've suggested that technological innovations, including automation and AI, are slowing hiring as employers determine whether or not to add to their payrolls. A shortage of workers with the right skills to match job openings may also be a problem. These structural issues in the labor market aren't likely to be solved by Fed rate cutting.

(6) Financial stability: valuation. Achieving the dual mandate requires financial stability. This should be the Fed's third mandate. Valuation multiples are clearly stretched, with the weekly Buffett Ratios at record highs for the S&P 500 and the Magnificent-7 (chart). Fed rate cuts risk triggering a meltup, and a meltdown could follow.

(7) Financial stability: margin debt. The bull market in stocks has been partly based on more leverage, with margin debt rising above $1 trillion in June for the first time on record (chart).

(8) S&P 500. Our current base case is that the rally in the S&P 500 stalls through September (chart). Profit-taking in technology stocks may be starting. October should provide buying opportunities and set the stage for a year-end rally to 6600 on the S&P 500, leading to 7500 in 2026.

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