Federal Reserve update: Dual mandate dilemma and muddied independence

On Sept. 17, the U.S. Federal Reserve moved forward with a widely expected quarter-point rate cut. More importantly, the Fed’s “dot plots,” which capture Federal Open Market Committee (FOMC) members’ expectations for the Fed’s future rate levels, indicated a dovish shift, implying an additional half-point of cuts for the balance of this year (or an ultimate rate range of ~3.5 percent-3.75 percent), and another quarter-point cut next year.

Rather than a nod to a slowing economy (second quarter GDP growth came in at a sizzling 3.8 percent), the impetus behind the rate cut was a signal to the markets that the balance of risks in the Fed’s dual mandate is currently skewed less toward inflation and more toward the labour market. This shift in balance comes in the wake of a meaningful downward revision in payrolls seen over the past few months, while unemployment crept higher in August (though it remains relatively low at ~4.3 percent).

Put differently, one could consider the latest move by the Fed to be akin to an “insurance cut,” while their commentary relayed low conviction on the path of interest rates moving forward. To wit, on the point of interest rate policy, Federal Reserve Chairman Jerome Powell stated in the post-meeting press conference that, “we’re in a meeting-by-meeting situation.” 

The Fed’s mandate of full employment and price stability are in fact moving in opposite directions, as stagflationary pressures seem to be building in the economy, and the narrative of U.S. exceptionalism fades. Indeed, August’s Consumer Price Index (CPI) inflation figures add fuel to this argument. Headline inflation crept higher to 2.9 percent year-over-year (which was largely in-line with consensus expectations), but more worryingly is that core CPI inflation (taking out energy and food inflation) accelerated for the third month in a row, and was up just over three percent year-over-year for the month.

In addition, the Fed must be aware that it is operating in an informational vacuum vis-à-vis the Trump administration’s tariff agenda, for which the renegotiation of CUSMA and the Supreme Court of the United States’ (SCOTUS) decision give rise to further uncertainty. Thus far it would seem that U.S. corporations have broadly shielded consumers from tariff-related price increases, but there is no telling how long a desire to support demand will give way to the necessity of protecting profit margins.

It’s also important to keep in mind that the substantial fiscal stimulus injected into the U.S. economy via the passage of the One Big Beautiful Bill—estimated to cost ~$3 trillion over the next 10 years according to the Bipartisan Policy Center —is in effect comparable to at least one or two de facto rate cuts, with likely more immediate impact (given that rate changes tend to impact the economy with a lag). As a result, the balance of risks could very well tilt back toward inflation over the months to come, and the aforementioned dovish stance could tilt back into hawkish territory, and result in a pause from the Fed at the next meeting at the end of October. Therefore, over the medium to long term, while a few more rate cuts may be on the horizon, a full-blown easing cycle is not our base case scenario.

The Fed is likely to remain data dependent. But what about independent?

As if it wasn’t enough to contend with a fluid and uncertain backdrop in which both sides of their dual mandates are being uncooperative; more recently, the Fed’s very independence has come under scrutiny.

President Trump has not been shy about his view that the Fed should not only be cutting rates but cutting them aggressively. The president has repeatedly and publicly criticized Powell for what he believes to be his too-cautious approach to cutting interest rates, nicknaming him “Too Late Powell.”  During his first term, the president considered firing the Fed chief (whom he appointed) but was disabused of that notion as swiftly as the markets revolted against it. He considered this again in his second term and even shared his inclination with fellow GOP lawmakers, who largely seemed to approve.

That Powell remains in his position nevertheless is likely owing to the weak grounds for firing that are specious at best. SCOTUS weighed in earlier this year; in that ruling they signaled that Chairman Powell is legally protected from being removed by the president on the grounds that the relationship between the commander-in-chief and the Fed is different from that of other independent agencies. Trump may have resigned himself to biding his time until Powell’s tenure as chairman expires next May, at which point it is not clear if he will retire or remain as governor of the Federal Reserve (with term expiry in Jan. 2028).

In August, Trump escalated his fight against the Fed by attempting to fire Federal Reserve governor Lisa Cook on the basis of allegations of mortgage fraud in connection with applications she filed for two residential properties she owns. Cook has since sued Trump in U.S. district court in Washington D.C. The presiding judge barred Trump from firing Cook in early September as her suit unfolds. Trump’s case against Cook now sits with the SCOTUS, which recently ruled that Cook is allowed to stay on as a Federal Reserve governor for now, in effect declining Trump’s request to immediately remove her. The court will hear arguments over her firing in January.

In a small win for Trump, he was able to select Stephen Miran—chair of the Council of Economic Advisors—to replace former governor Adriana Kugler, who resigned in early August. Miran will serve out Kugler’s term, which expires next January, at which point he may be reappointed. Note that Fed governors Christopher Waller and Andrea Bowman were nominated by Trump in his first and second terms, respectively.

For all the handwringing in the media and the admission of two new Fed nominees by Trump in his current term, we believe it may be too early to claim that its independence has been undermined. While much was made of the possibility of dissent from more than one member of the FOMC heading into the latest committee meeting, ultimately the sole dissenter was Miran, who voted for a half-point cut rather than a quarter-point cut. He was not joined by Waller or Bowman, though they have argued in favour of rate cuts and have dissented on interest rate decisions in previous meetings.

Indulge us in a hypothetical game of musical chairs for the Fed: in the event that Miran is reappointed, Cook is pushed out and Powell decides to retire, that would mark three potentially new FOMC members that could conceivably align more closely with Trump’s interest-rate agenda—out of the total of 12 committee members. If Waller and Bowman are also included in Trump’s rate cut camp, that takes it to five out of 12—still shy of a majority. Lastly, by the time many of these changes transpire (if they do), we are likely to be into the spring or summer of 2026, by which time rates could be lower and therefore the political pressure may recede from boiling point to simmer.  

We suspect that the potential for an adverse reaction toward a further undermining of the Fed’s independence may keep the bellicose rhetoric from the Trump administration at bay. A continuation of such would only add to the opacity for the Fed’s path going forward and may devalue its subsequent actions in the minds of investors. As Chairman Powell aptly stated at his most recent press conference, there are no “risk-free paths now, it’s not incredibly obvious what to do.” We are hard pressed to disagree.  

Bank of Canada cuts its benchmark rate and leaves room for flexibility going forward

The Bank of Canada (BoC) also cut its benchmark rate by a quarter-point to 2.5 percent during its September meeting in response to a weak jobs market (the unemployment rate hit a nine-year high recently, excluding the pandemic period), a contraction in second quarter GDP of 1.6 percent and somewhat tempered upside risks to inflation.

This was the first cut since March, and the BoC said it remained ready to cut further should economic data soften more meaningfully in the months ahead. Not surprisingly, BoC Governor Tiff Macklem underscored a still high level of uncertainty related to the U.S. tariffs. Slow population growth because of a meaningful pullback in immigration and persistent weakness in the labour market are expected to constrain household consumption for the next few months.

The BoC’s next meeting is scheduled for Oct. 29, ahead of the planned release of the federal budget on Nov. 4. Macklem provided scarce forward guidance at the September meeting and allowed the central bank a considerable level of flexibility against a turbulent economic backdrop.

During that time, September readings for inflation and employment, alongside the Q3 BoC business outlook survey, are likely to be closely watched and incorporated into the BoC’s next decision. We believe the central bank may seek to implement one more insurance-rate cut prior to the release of the budget, after which it may find that it is prudent to pause in light of the potentially inflationary impact the fiscal spending from the federal government may have, leaving rates at ~2.25 percent by the end of the year (in line with consensus).

RBC Economics views additional easing from the BoC to be likely in light of the economic concerns, unless the labour market demonstrates a meaningful improvement or inflationary pressures re-escalate.

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