Fed’s Waller backs 25bps rate cut in September as US inflation cools and labour softens

As the US Federal Reserve approaches its September meeting, mounting signals from central bank officials point to a likely initiation of monetary policy easing, with a 25 basis point reduction in interest rates emerging as a probable first step. This shift reflects growing confidence that inflation pressures have moderated sufficiently, allowing room to address emerging risks in the labour market without derailing economic stability. Such a move could ripple through financial markets, influencing everything from borrowing costs to asset valuations, and underscores a pivotal moment in the Fed’s post-pandemic strategy.

The Case for Easing: Balancing Inflation and Employment

The Federal Reserve’s dual mandate of price stability and maximum employment has been under scrutiny amid recent economic data. Inflation, as measured by the personal consumption expenditures (PCE) price index, has trended towards the 2% target, with the core PCE deflator registering 2.6% year-over-year as of June 2025, down from peaks above 5% in 2022. This cooling has been driven by a combination of supply chain normalisation and the lagged effects of prior rate hikes, which elevated the federal funds rate to a range of 5.25%-5.50% by mid-2023.

However, the labour market has shown signs of softening, prompting concerns that prolonged high rates could tip the economy into unnecessary slowdown. Nonfarm payrolls grew by an average of 170,000 jobs per month in the first half of 2025, a deceleration from the 250,000-plus pace seen in 2023. Unemployment ticked up to 4.1% in July 2025, according to Bureau of Labor Statistics data, signalling potential vulnerabilities. Analysts at J.P. Morgan Research, in a report dated 14 August 2025, noted that while the economy remains resilient, the balance of risks has shifted towards employment, justifying a calibrated easing cycle.

A 25 basis point cut would represent a measured approach, allowing the Fed to test the waters without committing to aggressive stimulus. This aligns with historical precedents, such as the 1995-1996 easing cycle, where the Fed trimmed rates modestly to support growth amid stable inflation. Economists polled by Reuters in mid-August 2025 largely anticipate this initial reduction, with a majority forecasting at least one more cut before year-end, contingent on incoming data.

Implications for the Broader Economy

Lower interest rates could provide a tailwind for consumer spending and business investment, which have faced headwinds from elevated borrowing costs. Mortgage rates, which topped 7% in 2023, have already begun to ease in anticipation, potentially reviving the housing market. According to the Mortgage Bankers Association, purchase applications rose 5% in the week ending 23 August 2025, reflecting improved affordability.

For corporations, cheaper credit might encourage capital expenditures, particularly in sectors like technology and manufacturing that have been sensitive to rate fluctuations. Yet, the impact may be muted if inflation reaccelerates, forcing the Fed to reverse course. Morningstar’s updated forecast from 26 June 2025 projects a total of 75 basis points in cuts by end-2025, assuming inflation holds steady, which could boost GDP growth by 0.3–0.5 percentage points in 2026.

On the flip side, persistent inflation concerns linger. Federal Reserve Chair Jerome Powell, in remarks at the Jackson Hole symposium on 22 August 2025, highlighted the “high level of uncertainty” surrounding the outlook, emphasising a data-dependent path. This cautious stance is echoed in sentiment from major brokerages; Barclays and Deutsche Bank, as reported by Reuters on 25 August 2025, pivoted to expecting a September cut following Powell’s focus on labour market risks.

Market Reactions and Investor Sentiment

Financial markets have priced in a high probability of easing, with futures implying around 90% odds of a 25 basis point move at the September meeting, based on CME FedWatch Tool data as of late August 2025. This anticipation has supported equity gains, with major indices advancing in recent sessions amid reduced recession fears.

Investor sentiment, as gauged by surveys from credible sources like the American Association of Individual Investors, shows a bullish tilt, with 45% of respondents optimistic in the week of 21 August 2025, up from 38% a month prior. However, this optimism is tempered by warnings from analysts at Morgan Stanley, who updated their forecast on 28 August 2025 to reflect Powell’s remarks, cautioning that the path beyond September remains murky due to potential fiscal and geopolitical variables.

Bond markets have adjusted accordingly, with the 10-year Treasury yield dipping below 3.8% in late August 2025, down from 4.7% peaks in 2024. This compression could benefit fixed-income portfolios, though it raises questions about yield curve normalisation. A model-based forecast from U.S. Bank, drawing on historical patterns from May 2023, suggests that gradual cuts might steepen the curve, enhancing returns for longer-duration assets.

Sector-Specific Opportunities and Risks

Rate-sensitive sectors stand to gain the most from easing. Real estate investment trusts (REITs) and utilities, which rely on debt financing, could see valuation multiples expand as discount rates fall. Conversely, financial institutions might face margin compression, though increased lending activity could offset this.

• Technology and Growth Stocks: Lower rates reduce the opportunity cost of holding non-yielding assets, potentially fuelling rallies in high-growth names. Analyst models project earnings growth of 12% for the sector in 2026 under a easing scenario.
• Consumer Discretionary: With household debt service ratios at 9.8% of disposable income as of Q2 2025 (Federal Reserve data), cheaper credit could spur spending on durables.
• Commodities: Gold has benefited from rate cut expectations, climbing above $2,500 per ounce in August 2025, as lower real yields enhance its appeal.

Risks include a resurgence in inflation, perhaps driven by supply shocks or robust wage growth. The Fed’s own projections from June 2025 indicate a median federal funds rate of 4.1% by end-2026, implying a shallow cutting cycle to guard against overheating.

Global Ramifications and Policy Outlook

The Fed’s actions carry international weight, influencing capital flows and exchange rates. Emerging markets, burdened by dollar-denominated debt, could see relief as the US dollar softens—a trend observed in the DXY index dropping 3% year-to-date through August 2025. European Central Bank officials have noted the spillover effects, with their own cuts in June 2025 partly calibrated to US moves.

Looking ahead, the September decision will hinge on key data releases, including the August jobs report due 5 September 2025. A softer-than-expected print could tilt towards a larger cut, though most economists favour starting small. As Powell indicated in his 22 August speech, reported by The New York Times, the “balance of risks” has shifted, raising the odds of action.

In summary, a 25 basis point cut in September would signal the Fed’s pivot from inflation-fighting to growth-supporting mode, with profound implications for investors. While it promises to alleviate pressures on the economy, the path forward demands vigilance amid uncertain data. Prudent portfolio adjustments, focusing on diversified exposure to rate-sensitive assets, could position investors to capitalise on this transition.

References

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• CNBC. (2025, August 22). Powell indicates conditions may warrant interest rate cuts as Fed proceeds carefully. Retrieved from https://www.cnbc.com/2025/08/22/powell-indicates-conditions-may-warrant-interest-rate-cuts-as-fed-proceeds-carefully.html
• Reuters. (2025, August 15). Most economists report US Fed will cut rates in September and once more this year. Retrieved from https://www.reuters.com/business/us-fed-cut-rates-september-once-more-this-year-say-most-economists-2025-08-15
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