The Fed’s Next Moves After Mixed Data

Summary

Podcast Summary: Thoughts on the Market – "The Fed’s Next Moves After Mixed Data"

Host: Aruna Masinha, Global Economist, Morgan Stanley
Date: August 20, 2025
Duration: ~4:26
Main Theme:
This episode examines the Federal Reserve’s likely policy path in light of the July 2025 Consumer Price Index (CPI) report, considering the ongoing implications for US inflation, labor market data, and the rippling effects on other central banks like the ECB and Bank of Japan.

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Key Discussion Points & Insights

1. Fed Policy Outlook After July CPI

• Baseline View:

  • Morgan Stanley’s core expectation remains that the Fed will stay on hold through 2025, unaffected by recent CPI data.
  • "Our baseline call has been that the Fed will remain on hold this year and last week's CPI print has not changed that view." (00:17)

• Tariff Impacts on Inflation:

  • Ongoing tariff rate increases are still feeding into prices—but with a lag. These effects are most evident in tariff-exposed goods, except for apparel and autos, which remain “firm.”
  • "Average tariff rates are still ramping up given the implementation delays, and so their cumulative effect on prices could be more lagged." (00:29)

2. Unexpected Services Inflation

• Surprise in July Data:

  • A reversal appeared in services inflation, driven by higher airfares and hotel prices—areas that had previously seen deflation.
  • Disproves the idea that slowing services inflation will fully offset rising goods prices from tariffs.
  • "The surprise came in services inflation which showed a reversal led by the uptick in airfares and hotel prices which had been running in deflationary territory for much of this year." (00:41)
  • "As this print showed, [services disinflation] is unlikely to be the case." (00:54)

• Core Inflation Still Elevated:

  • Both core CPI and core PCE inflation remain steady at last year’s pace—suggesting that overall inflation pressure persists.
  • "Both core CPI and core PC inflation are still at their pace from last year." (01:10)

3. Risks to the Fed’s Hold Call & Upcoming Data

• Fed’s September Decision Hinges on Data:

  • The August jobs report is critical.

  • If hiring rebounds and unemployment stays around 4.2–4.3%, the Fed will likely maintain its current stance, dismissing recent softness as a temporary blip after “Liberation Day.”

  • "If it is a solid employment report … then the Fed could likely look through the weakness in the May and June prints, attributing the slowdown to the uncertainty following Liberation Day." (01:37)

  • If, instead, the labor market weakens sharply, the Fed could reconsider, signaling potential easing.

  • "If, however, there were to be a sharp drop off in the hiring pace … then the Fed could take the view that the labor market is much weaker than anticipated and restart easing." (01:57)

• Risk Management Cut:

  • Even with inflation above target, downside labor market risk may prompt an early rate cut.
  • "There is also the possibility of a cut from a risk management perspective. Even with inflation running well above target, the Fed could take the July employment report as a clear signal of downside risk to the labor market and start the easing cycle." (02:07)

• Divergent Fed Messaging:

  • Officials are split—some stress labor market softness, others are less concerned due to continued low unemployment.
  • "Messaging from Fed officials has so far been mixed, with some taking signal from the jobs data and others remaining less worried with the unemployment rate remaining low." (02:20)

4. Implications for Other Major Central Banks

• ECB:

  • Euro area monetary policy remains tied to the US outlook; weakening US growth or stronger euro could support easing in Europe.
  • "Recent labor market data have introduced downside risks to our ECB … calls in Europe." (02:35)

• Bank of Japan (BOJ):

  • BOJ remains cautious; only a notably strong US economy might trigger a rate hike—October is a high bar, with December or later more likely.
  • If the US slows as forecast, further BOJ tightening grows less likely, strengthening the base case: BOJ on hold through 2026.
  • "In Japan ... stronger U.S. data could tilt the balance toward a rate hike later this year, though October remains a high hurdle, making December or beyond more plausible. That said, if the US Economy slows in line with our forecast, the likelihood of further BOJ tightening diminishes, reinforcing our base case the BOJ staying on hold through end of 2026." (02:52–03:18)

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Notable Quotes & Memorable Moments

• On persistent inflation risks:

  • "Further acceleration in goods inflation from tariff effects over the summer would still see inflation remaining well above the Fed's target." (01:15)

• On data-dependent Fed reactions:

  • "The road goes back to how the data and the Fed's reaction function will evolve over ahead of the September meeting." (01:25)

• On implications for Europe and Japan:

  • "Outside the US, Central bank trajectories remain tightly linked to both the Fed's path and the evolving US growth outlook." (02:26)

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Timestamps for Key Segments

• 00:17: Baseline Fed outlook and reaction to July CPI
• 00:29–01:10: Details on tariff effects and services inflation surprise
• 01:37–02:07: Discussion on August jobs report and its implications for Fed policy
• 02:20: Mixed messaging from Fed officials
• 02:35–02:52: Ripple effects for ECB and euro area policy
• 02:52–03:18: Bank of Japan’s caution and likely policy path

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Summary Conclusion

This episode provides a data-driven, nuanced look at the Federal Reserve’s next steps after mixed inflation and employment reports, reaffirming Morgan Stanley’s house view of the Fed staying on hold barring an unexpected shift in US labor data. The conversation then connects these US challenges to broader global central banking prospects, noting the interconnected nature of policy spillovers to Europe and Japan.

Quote to remember:
"The road goes back to how the data and the Fed's reaction function will evolve over ahead of the September meeting." – Aruna Masinha (01:25)

Transcript

[A]

Welcome to Thoughts on the Market. I'm Aruna Masinha, global economist at Morgan Stanley. Today, our evaluation of the Fed's policy path following the July CPI print and the broader implications for other central banks. It's Wednesday, August 20th at 2pm in New York. Our baseline call has been that the Fed will remain on hold this year and last week's CPI print has not changed that view. As we have noted, average tariff rates are still ramping up given the implementation delays, and so their cumulative effect on prices could be more lagged within the CPI print tariff exposed goods other than apparel and autos continue to be firm. The surprise came in services inflation which showed a reversal led by the uptick in airfares and hotel prices which had been running in deflationary territory for much of this year. Some of the pushback against our view on inflation stepping up over the summer due to tariffs was that services disinflation could compensate. But as this print showed, that is unlikely to be the case. While we expect services inflation to continue to moderate, we think that services disinflation in 1H25 was exaggerated by weakness in volatile competence. And both core CPI and core PC inflation are still at their pace from last year. So further acceleration in goods inflation from tariff effects over the summer would still see inflation remaining well above the Fed's target. After the July U.S. employment and CPI reports, the bar for the Fed to stay on hold in September is clearly higher. So what are the risks to our call? The road goes back to how the data and the Fed's reaction function will evolve over ahead of the September meeting. The August jobs report will be important. If it is a solid employment report with a sequential acceleration in payrolls and the unemployment rate around 4.2 to 4.3%, then the Fed could likely look through the weakness in the May and June prints, attributing the slowdown to the uncertainty following Liberation Day and not representative of the underlying trend. If, however, there were to be a sharp drop off in the hiring pace, which is currently not being indicated by other job market indicators such as jolts or claims, then the Fed could take the view that the labor market is much weaker than anticipated and restart easing. There is also the possibility of a cut from a risk management perspective. Even with inflation running well above target, the Fed could take the July employment report as a clear signal of downside risk to the labor market and start the easing cycle. Messaging from Fed officials has so far been mixed, with some taking signal from the jobs data and others remaining less worried with the unemployment rate remaining low outside the US Central bank trajectories remain tightly linked to both the Fed's path and the evolving U.S. growth outlook. Recent labor market data have introduced downside risks to our ECB and BOJ calls in Europe. If euro strength persists and US Recession risks rise, our euro area economists see a reduced risk to their September easing baseline in Japan. The bank of Japan remains cautious. Stronger U.S. data could tilt the balance toward a rate hike later this year, though October remains a high hurdle, making December or beyond more plausible. That said, if the US Economy slows in line with our forecast, the likelihood of further BOJ tightening diminishes, reinforcing our base case the BOJ staying on hold through end of 2026 thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

[B]

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