October 31, 2025
What surprise? The Fed did exactly what it was supposed to do, right? It cut rates by 0.25%. Everybody was on board with that decision except Stephen Miran who opted for a larger 0.5% cut. All as expected. With one exception. Kansas City Fed President Jeff Schmid opted for no change in rates. Nobody saw that coming! Does it mean anything? Of course. It means that the Fed may be close to a level of the funds rate that is deemed to be neutral and, as a result, there may be less room for rate cuts in the months ahead.
The Fed’s median official forecast for the neutral level of the funds rate is 3.0%. But nine of the 19 FOMC members believe the neutral level is higher than 3.0% with four of the nine suggesting it is 3.5% or above. To this group of people the current level of the funds rate at 3.75-4.0% is roughly where it should be for Fed policy to be “neutral”. That has got to be disturbing to Trump who has suggested that the neutral rate is 1.0%. As always, where the Fed goes from here will be data driven. Presumably the government shutdown will end prior to the next FOMC meeting on December 9 and 10, we will see a wide variety of postponed data, and everybody’s view of the appropriate Fed policy stance could change.
So how can Kansas City Fed President Schmidt conclude that no further rate cuts are required? Easy. He focuses on the above-target inflation rate. He said in early October that “the Fed must maintain its credibility on inflation”. The Fed wants the core personal consumption expenditures measure of inflation to be 2.0%. It is currently at 3.0%, has been above the 2.0% target for the past 4-1/2 years, and is not going to slow towards the 2.0% mark any time soon.
One factor that bothers him is that durable goods prices for motor vehicles, furniture, appliances and the like are rising. In the past year such prices have risen 1.8%. Schmidt says, “The fact that durable goods prices are increasing at all is notable. Outside of the disruption of the pandemic, the composite prices of durable goods has declined consistently for the past three decades. Given that durable goods tend to be imported or compete with imports, higher tariffs are likely contributing to the increase.” Given the weight of durables in the CPI index, it appears that tariffs have added 0.4% to the inflation rate this year.
The Fed believes that the effect on inflation from tariffs will be relatively short-lived and result in a one-time shift in the price level. But it recognizes that the inflationary effects could be more persistent. Given the Fed’s experience with inflation in 2021 and 2022 when it insisted that the run-up in inflation would be temporary, its recent track record does not inspire confidence.
The other factor that seems to have persuaded Schmidt to vote for no change in policy is his belief that the neutral level for the funds rate is probably 3.9%. The Fed does not identify which Fed official voted for each of the various estimates of the so-called neutral level for the funds rate, but it is likely that the highest estimate at 3.9% belongs to Schmidt. In early October he noted that “Financial market conditions appear to be fairly easy. Equity markets remain near record highs, corporate bond spreads are very narrow, and junk bond issuance is high. None of this suggests that financial conditions are particularly tight or that the stance of policy is restrictive.” He added that “I view the current stance of policy as only slightly restrictive, which I think is the right place to be.” At the time the funds rate was 4.0-4.25%. If he believed that the neutral funds rate was 3.9% Fed policy would have been slightly restrictive and appropriate, in which case he might not have been willing to go along with a further cut in the funds rate this past week.
The point of all this is that many FOMC members believe that the funds rate is not far from where it should be. Schmidt presumably believes the neutral level is 3.9%. Eight other FOMC members believe it is 3.5% or higher.
The markets still believe that an additional 0.25% cut to 3.5-3.75% is likely at the next FOMC meeting in December. We agree. But Chair Powell tried to throw some cold water on that notion. At the press conference he said, “A further reduction in the policy rate at the December meeting is not a foregone conclusion – far from it.” That is a rather emphatic statement.
The reality is that the Fed’s decision will be based on the data that are released between now and then. The government shutdown is now in its 31st day. The longest shutdown on record was 35 days in December 2018. The next FOMC meeting is six weeks away on December 9-10. It is inconceivable that the current shutdown will last that long. That means that we will see a lot of the missing data between now and then — GDP growth for the third quarter, payroll employment and the unemployment rate for September and October, personal income / spending, retail sales, and housing starts for September. If Fed decisions are data driven, data will help. Stay tuned!
Stephen Slifer
NumberNomics
Charleston, S.C.
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