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Powell’s Gamble: That the Economy Will Reveal Its True Self in the Next Two Months
Fed Chair Jerome Powell is keeping his options wide open for the September meeting, promising little while ruling out nothing.
Setting interest rates is sometimes more art than science, especially when the economy keeps defying predictions—a reality the Federal Reserve confronted head-on Wednesday.
There are two economic worlds the U.S. could be living in right now, and Fed officials might not know which one for months. In one, economic weakness that’s been lurking beneath reasonably solid headline numbers finally surfaces. In the other, artificial intelligence investment and buoyant household wealth power the economy past trade-war headwinds.
The Fed held rates steady this week, and Fed Chair Jerome Powell kept his options wide open for its next gathering in September, promising little while ruling out nothing.
Officials are betting they can afford to wait at least two months for clarity on whether tariffs will slow economic activity, fuel inflation, or pass by with little effect. That patience comes with risks—on both sides.
Powell suggested he was still committed to preserving the soft landing it looked like the economy had achieved at the beginning of the year, in which inflation had declined without significant damage to the labor market. By pushing up prices of some goods, tariffs have since created crosswinds that could blow the Fed off course.
The Fed provided extraordinary stimulus when the Covid-19 pandemic hit five years ago and was slow to withdraw it, leading to a blitz of rate hikes in 2022 when inflation proved more stubborn.
On Wednesday, the Fed chair repeated the pledge he made four years ago to make sure any price increases wouldn’t persist.
“We want to do that efficiently, though—efficiently,” he said at a news conference. Cutting rates too soon could force the Fed to come back later and raise them. “That’s inefficient,” Powell said. But waiting too long could cause unnecessary damage to the labor market.
In one economic world, the low and stable unemployment rate that Powell touted as a sign of economic stability is masking gradual labor market deterioration that could accelerate quickly.
“The unemployment rate being at 4.1% gives you a false sense of what’s actually going on in the job market,” said Neil Dutta, head of economic research at Renaissance Macro Research.
More people are out of the workforce who actually want jobs than is typical for an economy with such a low unemployment rate, said Dutta. An unusually high number of workers are seeing no wage growth, and barely half of industries have been adding jobs—a historically weak reading. Fed governor Christopher Waller flagged such concerns in a speech two weeks ago.
A shopper browses in a San Francisco bookstore. Pockets of weakness are showing up in consumer spending.
A world where the labor market is starting to come undone will validate Powell’s critics who say the Fed should have resumed cutting this week, if not earlier this year. Waller, who dissented from the Fed’s decision Wednesday because he favored a rate cut, has argued that the economy isn’t as strong as it might seem.
Powell didn’t dismiss those fears on Wednesday. The unemployment rate has stabilized because both the supply of workers and the demand for labor is falling at roughly the same pace. That’s one reason “we do see downside risk in the labor market,” he said.
Pockets of weakness are also showing up in consumer spending. Bank of America Institute data shows spending on services, such as hotels, airfares and dining, has declined for three straight months, the first time since 2008. Lower-income households saw credit-card spending decline in the three months through June for the first time in over a year.
Consumers are pulling back on discretionary categories like travel and dining even as nondiscretionary costs like insurance and rent continue climbing.
“If you were to say, ‘what is the temperature of the consumer right now?’ I would tell you that it’s cooling but it’s not frozen. It’s not collapsing,” said Liz Everett Krisberg, head of the Bank of America Institute.
Housing markets represent another source of economic drag that could amplify labor market weakness. Residential investment has been declining and inventories of for-sale housing are growing, a sign that more housing markets are exhausting the universe of buyers willing or able to purchase homes with mortgage rates above 6.5%.
Fed governor Christopher Waller dissented at Wednesday’s meeting in favor of a rate cut.
But there’s a competing view that sees these warning signs as noise rather than signal. In the second world, the economy’s track record of defying predictions continues, powered by forces that could override the emerging weakness.
The economy has motored through a swift run-up in interest rates in 2022, a regional banking crisis in 2023, and now trade disruptions in 2025, said Ajay Rajadhyaksha, global chairman of research at Barclays.
Rajadhyaksha highlights two key factors sustaining the economy: a boom in AI investment that has offset weakness in rate-sensitive sectors, and a considerable wealth buildup from higher home prices and stock portfolios that could support consumer spending by the well-off.
“Every time I go to Asia or Europe, I’m reminded that people don’t realize how much richer in the last four years U.S. households have become than the rest of the world,” he said.
Absent some unforeseen shock such as a swift jump in long-term government-debt yields, “I have a very hard time seeing an outright recession in the United States,” Rajadhyaksha said.
In this state of the world, the Fed would have little reason to cut this year, said Michael Gapen, chief U.S. economist at Morgan Stanley. Even if tariff-related price hikes prove temporary, as Waller expects, they could set up a problematic sequence if, for example, Republicans’ tax cuts or potential consumer rebates boost spending.
“It’s not the tariffs that create the persistence; it’s the demand side that feeds off of that tariff story,” Gapen said.
Rajadhyaksha thinks higher prices from tariffs will be a one-off, but he thinks the Fed will be hard-pressed to cut in September because those price increases will show up in the July and August inflation reports due beforehand.
Claudio Irigoyen, a former central banker in Argentina who now heads global economic research at Bank of America, called it risky to assume the answers to any tariff shock could be fully resolved in a matter of months.
“The pandemic was also a temporary shock that the Fed decided to look through, and they were wrong,” he said. “Not because it wasn’t temporary, but because temporary means a year and a half or two—long enough for you not to ignore it.”
He pointed to other risks of financial froth that call into question the case for lowering rates. If rate cuts are urgently needed, “why is the stock market going up every day?” asked Irigoyen. “Why is private credit booming?”
Powell didn’t sound like someone in a rush to find out. “I think you have to think of this as still quite early days,” he said, referring to understanding the effects higher tariffs will have on the economy. “We’re just going to have to watch and learn.”
Write to Nick Timiraos at Nick.Timiraos@wsj.com
