Cautious Consumers Pull Back as Tariff-Driven Inflation Risks Rise

**Ivanna Hampton: **A divided vote from the Federal Reserve kept interest rates right where they are, for now. Fed Chair Jerome Powell says the committee members clearly laid out their positions. Pressure is intensifying from the White House to lower rates. Meanwhile, signs are showing that the economy is slowing while inflation remains somewhat elevated. What does this mean for the Fed as anticipation builds for their September meeting? Joining me is Preston Caldwell, a senior US economist for Morningstar Investment Management.

Thanks for joining me, Preston.

**Preston Caldwell: **Hey, Ivanna. Thanks for having me.

What Investors Need to Know About the Lack of Consensus at the Fed

**Hampton: **Well, two Fed governors dissented, making it a rare occurrence. Powell called it one of their better meetings. What do you make of the lack of consensus?

**Caldwell: **Yeah. So, you know, I think I read it’s the first time you’ve had two dissents since 1993 maybe. So, yeah, in any case, it would seem odd to call that a good meeting. But I think it’s good to have diverse perspectives in this situation, which is a situation in which there’s a lot of uncertainty about the right path forward for monetary policy and how the economy is going to continue to process the impact of the tariff hikes.

The Fed Tees Up a September Rate Cut, but Will it Happen?

As well as how the economy is going to react, will continue to react, to interest rates that are assessed as being moderately restrictive by Powell and the Fed. And clearly some committee members think that rates should move in a somewhat less restrictive direction in order to address the downside risks to economic activity that could come from tariffs. And also just to reflect the perhaps downtrend in economic activity that we’re seeing in the data.

Whereas, and also I would say, if you look at the Fed’s official meeting statement, that also showed signs of reflecting those views of those committee members who push in that more so-called dovish direction. When we say dovish, we mean kind of favoring lower rates. Hawkish means higher rates, of course. And also, in the Fed’s latest projections in June, they had already called for two rate cuts in the rest of 2025.

Well, we only have three more meetings, so that implies cutting two out of those three remaining meetings. You know, that would seem to set up for a September rate cut. But, despite all that, Powell himself in the press conference kind of struck a different tone. He seemed more hawkish to me, emphasizing more the risks to inflation and downplaying, or de-emphasizing at least, the risks to economic growth, which, in his view, makes rate cutting less urgent.

And he certainly didn’t rule out a rate cut in September, but I do think, though, Powell is probably shaking out a little bit more on the hawkish wing of the committee at this stage. And so I would still expect a rate cut to come in September, but I think it will be close. It’s definitely not a sure thing in my view.

Interest rate Forecast 2025

Hampton: And quickly, what’s your interest rate forecast?

**Caldwell: **So in addition to a cut in September, I would expect two cuts altogether this year, which is about in line with, again, the prior Fed projections as I mentioned, as well as close to what the market’s implying.

And then I do think where I do diverge a little bit from what market expectations, what consensus is, is that I think we’ll see three more rate cuts in 2026 and another three in 2027, taking the federal funds right down by accumulative 200 basis points from current levels.

So going from a target range of 4.25% to 4.50% to 2.25% to 2.50% by the end of 2027, which would put rates quite a bit closer to prepandemic conditions, which is my assessment of where the neutral rate of interest is, is quite a bit below current levels.

Is There a Risk From Slower Economic Growth From the New GDP Report?

**Hampton: **Let’s talk about the new GDP report. Economic growth in the first half of 2025 has slowed compared to the last few years. How are you interpreting this data, and what, if anything, is showing a risk?

**Caldwell: **Yeah, so right.So we had GDP growth averaging 1.2% in the first half of 2025, compared to an average of 2.7% over 2022 to 2024. So, we’re counting that growth regime where GDP growth was 2.5% to 3% for a while, and now maybe it’s 1% to 1.5%, based on the first half of the year.

But as Powell noted, and this is correct, GDP is volatile. And even looking at a full one half of the year average isn’t enough to smooth out all the noise. So, we could easily see things bounce back in the second half of the year. And that argues for looking through the noise. On the other hand, I do think though that we are seeing a genuine downtrend in growth now. I think the slowdown in consumption that we’re seeing, I don’t think that that is transient. I think that that reflects consumers getting more cautious after a period where savings rates have been below prepandemic levels.

And I also think residential investment, which declined outright in the first half of 2025, is under pressure with mortgage rates being as high as they are. Which is part of that—that’s kind of a more tangible realization of that story that I’ve told, that neutral rates are quite a bit lower than prevailing interest rates right now, that homebuyers ultimately need much lower mortgage rates in order to sustain current levels of housing demand.

Now, one thing I would add is that Powell also emphasized the fact that labor markets have been very stable. Unemployment has been kind of bouncing around 4.1% to 4.2% for several months now, nearly a year now, actually. So it’s true that, strictly speaking, the Fed’s dual mandate focuses on inflation and maximum sustainable employment. But the thing about employment, the thing about labor market conditions, is they’re a lagging function of economic growth. So, if economic growth decelerates, and especially if it goes into a recession, then the labor market deteriorates as well. So, and also, it’s a lagging indicator, so really what the Fed needs to be focusing on is economic growth itself.

So, I thought it was a little odd today that Powell downplayed some of the signs of decelerating economic growth pointing to the labor market, because if we wait for the labor market to deteriorate, it may be too late for the Fed to respond. So, that would be one quibble that I would have with Powell’s overall logic that he presented today, if I had to find one.

Would Tariffs Cause a Price Increase for Consumers?

**Hampton: **Well, tariffs are expected to increase cost for consumers when retailers raise their prices. Powell says the reasonable base case would be a one-time price increase. Do you agree, and when could consumers start seeing higher prices?

**Caldwell: **Yeah, so I would agree overall. Well, let me say first off, we have, I think, begun to see some tariff impact on prices. So, we’re overall at a situation where core inflation was 2.7% year over year in the second quarter of this year, so that’s hardly improved from the 2.8% on average in 2024.

So, inflation really is no longer clearly trending down, and that’s—even though the housing component of inflation is going down—that’s been offset by renewed acceleration in core goods price inflation, including durable goods like electronics, TVs, and nondurable goods like apparel and other items that seem to be showing the early signs of tariff impact, but still only a fraction of the impact that we would expect based off the tariffs that have been imposed.

And I think Powell’s assessment is correct, that right now businesses, US businesses, are bearing the tariff burden, but it’s very likely that they’re going to pass on more of that burden to the consumer in the form of price hikes over the next year. So, even though that’s happened a bit slower than expected at first, it’s still somewhat inevitable from an economic standpoint that those cost increases get passed on to the consumer to a great degree.

So, that is going to exert upward pressure on the inflation rate in the near term. Nothing like the inflation that we saw all over 2021 and 2022, I think, when inflation got to a peak of 6.6% on average in 2022 for the PCE Price Index, but I think we’ll see inflation in 2026 a little over 3% on average for the year. So, it’s enough above the Fed’s 2% target to definitely call, in isolation, call for continued moderately restrictive monetary policy. But on the other hand, I do think that there are downside risks to growth that are materializing and are increasing, and tariffs will cause further downside risk.

And I think that does, on net, push for the Fed to look through this one-time, what is likely to be a one-time, uptick in inflation, and ease interest rates incrementally over its next several meetings.

**Hampton: **And I know you will be tracking all of this between now and the September meeting. Thank you, Preston, for your time today.

**Caldwell: **Thanks, Ivanna.

Watch Where Should Investors Look Next Among Economic Mixed Messages? featuring Morningstar CEO Kunal Kapoor and Preston Caldwell.