Temporary inflation drivers, ranging from tariff pressures to energy costs, are expected to fade over time. The Federal Reserve's monetary policy is at a pivotal juncture as the Federal Open Market Committee (FOMC) remains divided on whether additional rate increases are necessary to curb inflation, while President Donald Trump continues to advocate for rate cuts to spur economic growth.
Ahead of the release of last month's Fed meeting minutes, Goldman Sachs has indicated that, based on the latest economic data, it is unlikely enough committee members will shift to a hawkish stance by next month's meeting to justify a rate increase.
Since February 2026, elevated oil prices driven by the US-Israel-Iran conflict have kept inflation well above the Fed's 2% target. Fed Governors Christopher Waller and Lisa Cook have recently signaled they would support a rate hike unless inflation cools rapidly. Fortunately, recent data appears to support a cooling scenario; July's Producer Price Index was unexpectedly flat month-over-month, the Consumer Price Index for July surpassed expectations, and June's CPI had already shown a decline.
Markets have responded to these developments. Following weaker-than-expected employment losses and softer CPI/PPI readings in July, traders have significantly reduced bets on a September rate increase. However, pricing still indicates a greater than 90% probability of a hike before year-end.
Richmond Fed President Thomas Barkin noted last Thursday that many believe the current interest rate level retains sufficient restrictiveness to guide inflation downward. He attributed a significant portion of the current inflation acceleration to external shocks, such as tariff increases, higher oil prices, and the artificial intelligence investment boom, all of which will eventually subside. Barkin argued that both financial markets and the public have recognized the recent easing in price pressures, which reduces the need for a rate increase even after five consecutive years of inflation above target. He emphasized that increased headlines about inflation retreating helps anchor public inflation expectations.
Still, improving price readings may not be enough to placate the hawkish camp. The core concern is that five straight years of above-target inflation could lead to unanchored expectations, making future efforts to control prices more costly. Cleveland Fed President Beth Hammack posed a critical question: "The issue is how quickly we need to achieve the 2% inflation goal. We might eventually get there, but if it takes another three or four years, is that acceptable?"
At the conclusion of next month's meeting, Fed officials will update their dot plot and economic projections. As of mid-June, most officials anticipated that the core Personal Consumption Expenditures price index would land in the 2.2%-2.5% range by the end of 2027. To reach that range, only half of Waller's colleagues believe at least a 25-basis-point hike is necessary this year; among the rest, all but one view holding rates steady as appropriate.
Meanwhile, President Trump continues to pressure for substantial rate cuts and has accused Waller's "hostile" colleagues of obstructing such moves. With midterm elections approaching in November, high living costs remain a political vulnerability for Trump, who campaigned on lowering prices during his 2024 presidential run. Waller himself has remained silent on policy plans, offering no forward guidance.
Currently, there is little data supporting the rate cuts Trump desires. The decision on whether to hike increasingly hinges less on economic indicators and more on policymakers' subjective assessments of risks to public inflation expectations. The Fed worries that the longer inflation stays above the 2% target, the more likely the public will lose faith in the target, potentially driving prices higher and making anti-inflation efforts costlier.
The Fed will release its July meeting minutes this week, offering clues about the potential policy outlook. Before the September meeting, the Fed will have two key data points: the July Personal Consumption Expenditures report—its preferred inflation gauge, which read 3.7% in June—and the latest jobs report.
Goldman Sachs has revised its stance. Previously, Robert Kaplan, the firm's vice chairman and former Dallas Fed president, had projected the Fed might need to hike as early as September if inflation remained persistent. Now, the Wall Street bank has changed its mind.
Goldman's chief economist, Jan Hatzius, wrote on Sunday that July retail sales declined, and US consumers will remain under pressure due to elevated energy prices. Given the ongoing shipping disruptions in the Strait of Hormuz pushing up gasoline prices, consumer spending growth in the second half of the year is expected to slow to 1%-1.5%. Hatzius noted that some resilience in spending during the first half of 2026 came from tax rebates. Despite a mildly positive wealth effect from stronger equity markets, he expects economic activity to remain below potential output in the second half.
Employment data corroborates this view: the underlying trend in July job growth was just 5,000 positions, well below the breakeven threshold of 50,000 per month. Wage growth remains weak, contradicting the narrative of a persistently tight labor market.
However, inflation data is the most critical support for this assessment. The PCE price index is expected to rise 0.2% month-over-month in July. Hatzius anticipates that temporary inflation drivers, such as tariffs and energy costs, will eventually fade, with core PCE annual inflation returning to the 2% target by 2027. As the year progresses, the likelihood of further improvement in inflation outweighs the risk of deterioration. Consequently, market pricing for the federal funds rate appears overly hawkish.
Goldman Sachs concludes that, ahead of the September meeting, it is unlikely enough FOMC members will pivot to a hawkish stance to trigger a rate hike. Unless August economic data shows a dramatic and unexpected shift, the Fed will likely hold rates steady.
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