Inflation and Growth Forecasts Rebound, but Rate Pressures Mount
The Fed assumes inflation will continue rising. The Atlanta Fed’s real-time GDPNow estimate jumped from 2.2% to 3.5% for Q3.
Quick overview
- The U.S. economy showed strong growth in Q2 at +3.3%, with consumer spending rising 0.3% in July despite inflation concerns.
- Inflation is projected to rise to 4.8% over the next year, but the PCE index remains steady at 2.6%, with core inflation at 2.9%.
- President Trump has controversially dismissed Fed Governor Lisa Cook, raising concerns about the independence of the Federal Reserve.
- The upcoming August jobs report and benchmark revisions could significantly impact the Fed's decision on potential rate cuts.
The U.S. economy entered Q3 on solid footing, after closing Q2 stronger than expected at +3.3%. Consumers remain highly skeptical, yet they continue to spend—and in July, spending rose another 0.3%. What they fear most is inflation.
Will it really climb to 4.8% over the next year, as surveys suggest? That seems like an exaggeration. In July, the PCE index tracked by the Federal Reserve (Fed) held steady at 2.6%. Core inflation edged up just one-tenth of a point, to 2.9%—exactly the figure Fed Chair Jay Powell flagged a week earlier at Jackson Hole.
The Fed assumes inflation will continue rising in the near term, driven largely by tariff pressures, but expects it to reverse next year as the one-off price impact fades. In its June projections, core inflation climbs to 3.1% by December before easing to 2.4% by end-2026. That outlook is consistent with two rate cuts totaling half a percentage point before the end of 2025—without waiting for inflation to visibly roll over. On this front, there were no real surprises.
So, what changed since Jackson Hole?
Two major—and aggressive—developments. On the economic front, the Atlanta Fed’s real-time GDPNow estimate (notoriously volatile) jumped from 2.2% to 3.5% for Q3. On the political front, the bombshell: President Trump directly intervened in the composition of the Fed’s Board of Governors. He demanded the resignation of Governor Lisa Cook, one of the seven members (including Powell), citing “potentially criminal conduct” tied to alleged irregularities in two personal mortgages. When she refused, Trump summarily dismissed her via a Truth Social post “with immediate effect.”
Never in the Fed’s 111-year history has a President removed a Governor. Never has the central bank’s independence faced such a direct threat. The outcome, however, remains uncertain. Cook—appointed by President Biden and confirmed by the Senate—is refusing to step aside and has sued Trump over the dismissal attempt. She has warned she would do the same if any colleague tried to force her out.
On Friday, Federal Judge Jia Cobb held a preliminary hearing with Cook’s lawyers and the Justice Department, but has yet to issue a ruling. Will Cook be allowed to vote at the next FOMC meeting? She should—but she has not yet received a legal injunction that would eliminate all doubt. Neither Powell nor any Fed official has commented. Markets, too, have shrugged it off—just as they did when Trump recently floated (and later denied) the idea of firing Powell himself.
The silence suggests acquiescence. Only the courts may now reaffirm the Fed’s independence and set explicit limits on executive overreach. Indeed, the Federal Circuit Court of Appeals just struck down Trump’s “reciprocal tariffs,” ruling they exceeded presidential authority. The White House plans to appeal to the Supreme Court.
The economy is sending stronger signals. Inflation and spending are rising together. Politics is breathing down the Fed’s neck. Wall Street posted record highs in August with barely a sign of worry.
Will rate cuts be needed at the September 16–17 meeting? Nothing so far has altered the odds. Chicago futures currently price an 86.4% chance of a cut, up slightly from 84.7% a week earlier.
Should Powell strike a tougher stance to defend the Fed’s credibility?
No one thinks so—and the bond market isn’t demanding it. The data will decide. A sharp jump in August inflation would force a rethink. But more likely, it will be the labor market that tips the balance.
The August jobs report comes out Friday (along with revisions for June and July). But the critical date is Tuesday the 9th, when the annual benchmark revisions are released. A sizable downgrade is expected. Fed Governor Waller estimates current data may be overstating payrolls by about 60,000 jobs per month—and that the revisions could reveal net private-sector job losses over the past three months. If confirmed, it would all but guarantee a unanimous Fed vote for a rate cut aimed at supporting labor demand—even if the broader economy, since July, looks stronger and, according to the latest PMI, is accelerating.
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