Fed FOMC Meeting September 2025 - My Take

Key Concepts

• FOMC Rate Decision: The Federal Open Market Committee's decision on interest rates.
• Fed Funds Rate: The target rate for overnight lending between banks in the US.
• Balance Sheet Shrinking (Quantitative Tightening): The Federal Reserve reducing its holdings of assets by allowing them to mature without reinvestment.
• Labor Market Deceleration: A slowdown in job creation.
• Inflation: The rate at which prices for goods and services are rising.
• Tariffs: Taxes imposed on imported goods.
• GDP Growth: The rate at which the economy is expanding.
• Fed Independence: The Federal Reserve's ability to make monetary policy decisions free from political influence.
• Monetary Policy Committee (MPC): The UK's equivalent of the FOMC.
• Dissent: A vote against the majority decision by a member of a committee.
• Summary of Economic Projections (SEP): A report from the Fed detailing its economic forecasts and policy path.
• Dot Plot: A graphical representation of FOMC members' individual projections for the future federal funds rate.
• Neutral Rate: The theoretical interest rate at which monetary policy is neither expansionary nor contractionary.
• Fed Funds Futures Market: A market where traders bet on the future direction of the Fed Funds Rate.
• Pass-Through Inflation: The extent to which increased costs (like tariffs) are passed on to consumers.
• Bureau of Labor Statistics (BLS): The US government agency responsible for producing labor market data.
• Non-Farm Payrolls: A key indicator of job creation in the US.
• Yield Curve: A graph showing the yields of bonds with different maturities.
• Schiller Cape Ratio: A valuation metric that adjusts the price-to-earnings ratio for economic cycles.
• Market Cap: The total market value of a company's outstanding shares.
• Investment Grade Bonds: Bonds with a relatively low risk of default.
• Junk Bonds (High-Yield Bonds): Bonds with a higher risk of default.
• Credit Spreads: The difference in yield between two bonds of similar maturity but different credit quality.
• Default Storms: A period of widespread corporate defaults.
• Bitcoin: A decentralized digital currency.
• Exchange Traded Notes (ETNs): Debt instruments that track an index, issued by a financial institution.

FOMC Rate Decision and Economic Outlook

The Federal Open Market Committee (FOMC) decided to cut interest rates by 0.25%, bringing the Fed Funds Rate down to a new range of 4.00% to 4.25%. This decision was largely anticipated, with the Fed Funds futures market pricing in a 96% probability of a rate cut. Alongside the rate cut, the Fed will continue to shrink its balance sheet by allowing Treasuries to mature.

The primary drivers behind this decision were concerns about the labor market, which has shown a noticeable deceleration in job creation throughout the year. While overall economic growth has not yet significantly weakened, the expectation is that it will follow the slowdown in employment.

Inflation has been ticking upwards, with a significant portion of this increase attributed to goods inflation driven by tariffs, rather than wage growth. The sticky nature of this tariff-driven inflation is a key concern, as it could necessitate a slowdown or reversal of rate cuts if it persists.

Despite these concerns, the Summary of Economic Projections (SEP) indicated that GDP growth forecasts for 2025-2027 have been revised upwards, suggesting that a severe recession is not the central case. The labor market remains relatively healthy with low unemployment, but the slowing trend is a point of concern for the Fed.

Political Considerations and Fed Independence

A significant portion of the discussion and questions at the subsequent press conference revolved around Fed independence, particularly in light of recent nominations and political pressures. The end of Jerome Powell's term as Fed Chair is scheduled for May of the following year.

A notable point of contention was the dissenting vote of Steven Moran, who advocated for a larger 0.50% rate cut. This was seen as unusual given the current economic data. Moran's appointment and his continued role as Chair of the White House Council of Economic Advisors (albeit on unpaid leave) while serving on the Fed board raised questions about potential conflicts of interest and the erosion of Fed independence. Senator Jack Reid's comment that President Trump could instruct Moran to take certain actions highlighted these concerns. Moran's own statement that he didn't expect bond markets to react negatively to a potential loss of Fed independence was met with skepticism.

Powell, when questioned about Moran's dual role and its impact on Fed independence, stated that the committee remains united in pursuing its dual mandate goals and is strongly committed to maintaining its independence, but declined to comment further on the specific situation.

Comparative Monetary Policy and Economic Projections

The Federal Reserve's current policy stance, with rates between 4.00% and 4.25%, places it at the top of the pack among major central banks in terms of interest rates. This is in contrast to the Bank of England (4%), Australia (3.6%), Canada (2.75%), and the Euro area, which has been cutting rates aggressively. The Fed has been the most cautious in its rate-cutting approach.

The Summary of Economic Projections (SEP) revealed several key revisions:

• GDP Growth: Forecasts for 2025, 2026, and 2027 were revised upwards. A new forecast for 2028 was introduced at 1.8%, aligning with longer-run expectations.
• Unemployment Rate: Projections were slightly lowered for 2027 and 2028, moving towards the longer-run average of 4.2%.
• Inflation: Expectations for inflation were revised slightly upwards for 2026.
• Policy Path (Dot Plot): The projected path for the federal funds rate was revised downwards, particularly for 2025, indicating an expectation of more cuts than previously anticipated. The neutral rate is still expected to be reached around 2027.

Market Expectations vs. Fed Projections

The Fed Funds futures market indicated strong expectations for rate cuts. As of the morning of the announcement, there was a 96% probability of a cut, with expectations for further cuts in October and December, totaling three cuts for the year. Markets were anticipating a more aggressive cutting cycle than the Fed's own projections.

Balance Sheet Runoff

The Fed's balance sheet runoff has slowed down, with total assets now just under $7 trillion, significantly below the previous $9 trillion. This deceleration in quantitative tightening is seen as a form of monetary easing.

Press Conference Highlights and Key Concerns

The press conference focused on several critical areas:

• Political Influence: Powell reiterated the Fed's commitment to making decisions based solely on economic data and its culture of independence. He emphasized that the Fed's actions and communications would demonstrate its non-political motivation.
• Pass-Through Inflation: The potential for importers to pass on tariff costs to consumers was a major topic. Powell acknowledged that companies have absorbed some of these costs but indicated an intention to pass them through eventually. The impact is expected to be gradual but clear.
• Data Quality and Political Interference: Concerns were raised about data quality and the potential for political interference. The recent firing of the head of the Bureau of Labor Statistics (BLS) was highlighted as a worrying precedent, suggesting a potential incentive to manipulate data to please the president. This behavior was likened to that seen in emerging markets.
• Non-Farm Payrolls: The trend of weakening job creation was discussed, with recent revisions showing a significant decline from the strong numbers seen in 2023. With reduced immigration, the neutral rate to absorb new entrants is estimated at 50,000 new jobs per month, a level that recent prints have fallen below.
• Yield Curve: The long end of the yield curve has been moving upwards, even as the Fed cuts rates, leading to a steepening of the yield curve. This is seen as a market concern about political and economic stability.

Valuation and Market Analysis

The discussion shifted to market valuations, with a focus on identifying "cheap" assets:

• Country Valuations (Schiller Cape Ratio):
  • Expensive: Taiwan (94th percentile), US (92nd percentile), India (88th percentile), Netherlands, Australia, Germany, Canada.
  • Moderately Valued: UK (61st percentile).
  • Cheap: Emerging Markets (EM) generally, Japan, Mexico, Turkey, Brazil. China is noted as becoming less cheap.
• US Market Cap Valuations:
  • Large Caps (S&P 500): Valued at 22 times forward earnings, considered very expensive and priced for perfection.
  • Mid Caps: Valued at 16.2 times forward earnings, appearing relatively cheap.
  • Small Caps: Valued at 15.6 times forward earnings, also appearing relatively cheap.
  • The speaker suggests that mid-caps might be a more prudent investment than small caps if the economy weakens, due to their potentially stronger balance sheets.

Risk of a 2008-Style Crisis

The possibility of another 2008-style crisis was raised. The speaker noted a significant concentration of Triple B-rated bonds (one notch above junk) within investment-grade funds like LQD. A credit deterioration event could lead to a downward spiral of downgrades and widening credit spreads, potentially triggering a "default storm." The current market is described as being in a "quiescent state" with low credit spreads, meaning investors are not adequately compensated for risk. The market is seen as being priced to perfection, similar to the pre-2007 period, with a worrying lack of concern about potential risks.

Bitcoin and Speculative Assets

The discussion on Bitcoin concluded that it is largely a speculative asset due to its high volatility. Its price movement is closely correlated with the NASDAQ 100, suggesting it is driven by euphoria and narrative rather than fundamental value. The speaker noted that even some individuals in the crypto space do not hold crypto themselves. The introduction of regulated crypto ETNs in the UK is seen as a safer way to gain exposure compared to unregulated crypto exchanges.

Upcoming Events

The speaker announced a follow-up session the next day at 6:00 PM UK time to cover the Bank of England's rate decision.