Why is the Federal Reserve unwilling to cut interest rates?

I. Persistent Inflationary Pressures

1. Core Inflation Remains Elevated
   While headline inflation has moderated, core inflation (excluding food and energy) continues to exceed the Fed’s 2% target. Recent data indicates that core PCE inflation remains stubbornly high, driven by services and non-tradable sectors. Market-based inflation expectations have also edged upward, signaling lingering concerns about price stability.
2. Structural Inflation Risks
   U.S. consumption-driven demand (accounting for a significantly higher share of GDP compared to other economies) continues to fuel inflation in domestic services. Long-term pressures, such as tariffs and supply chain reconfiguration, risk embedding higher inflation expectations, limiting the Fed’s policy flexibility.
3. Historical Caution
   Federal Reserve Chair Jerome Powell has repeatedly emphasized the dangers of premature easing, citing lessons from past policy mistakes. For instance, a premature rate cut in a previous instance triggered a surge in inflation expectations, reinforcing the need for vigilance.

II. Resilient Labor Market Dynamics

1. Strong Employment Indicators
   The labor market remains robust, with unemployment near historic lows and steady job creation. Wage growth continues to outpace inflation in certain sectors, reducing urgency for monetary stimulus.
2. Wage-Price Spiral Concerns
   Despite slower nominal wage growth, real wages remain compressed due to earlier inflation spikes. Lowering rates prematurely could reignite cost-push inflation by incentivizing businesses to pass on higher labor costs to consumers.

III. External Uncertainties and Global Risks

1. Trade Policy Impacts
   Tariff measures are seen as a dual threat: they risk elevating input costs for businesses while dampening growth. The Fed is closely monitoring these effects to avoid policy missteps.
2. Global Financial Stability
   The U.S. dollar’s dominance amplifies the spillover effects of Fed decisions. Maintaining steady rates helps stabilize global capital flows and preserves the dollar’s appeal as a reserve currency.

IV. Prudent Policy Stance Among Fed Officials

1. Data-Dependent Approach
   Policymakers stress the need for “greater confidence” in inflation’s downward trajectory before considering cuts. Recent meeting minutes highlight a consensus to prioritize sustained disinflation over short-term growth risks.
2. Restrictive Policy Assessment
   Current interest rates remain above the estimated neutral level, allowing the Fed to maintain pressure on demand without stifling economic activity. Premature easing could undermine progress toward price stability.

V. Managing Market Expectations and Credibility

1. Guiding Investor Sentiment
   The Fed has recalibrated market expectations through forward guidance, shifting projections from aggressive cuts to a more gradual easing path. This reduces volatility and aligns markets with policy realities.
2. Upholding Institutional Credibility
   After earlier criticism for underestimating inflation, the Fed now prioritizes transparency and consistency. Powell has reaffirmed the central bank’s independence, resisting political pressure to cut rates prematurely.

VI. Long-Term Economic and Policy Considerations

1. Ongoing Framework Review
   A review of the Fed’s monetary policy strategy—including potential adjustments to inflation targeting and employment goals—has delayed major policy shifts until clearer guidelines emerge.
2. Fiscal-Monetary Tradeoffs
   High fiscal deficits complicate policy decisions, as rate cuts risk exacerbating debt-driven inflation. Balancing short-term stimulus with long-term fiscal sustainability remains a key challenge.

Conclusion: A Multifaceted Balancing Act

The Fed’s reluctance to cut rates reflects a cautious calculus: maintaining restrictive policy guards against inflation resurgence while preserving optionality amid global uncertainties. A shift toward easing is unlikely until core inflation trends decisively toward 2% and structural risks (e.g., trade policies) stabilize. This stance underscores the Fed’s commitment to prioritizing long-term stability over short-term gains.