Federal Reserve "third-in-command": Tariff impact gradually fading, inflation continues to show a downward trend

According to Zhitong Finance APP, John Williams, President of the New York Federal Reserve and the “third-ranking” official at the Fed with permanent voting rights, said there is evidence that inflation is continuing to cool as the impact of tariffs gradually fades, and that the rise in energy prices has not spread to other service sectors.

In an interview on Wednesday, Williams said, “The latest data is encouraging. In fact, I see the inflation trend slowly declining as some of the effects of tariffs are gradually fading into the past.” He added that the biggest factors currently driving inflation remain tariffs and rising energy prices due to the Middle East conflicts, “There is still some impact on service sector inflation remaining elevated.”

Meanwhile, Williams supports the Fed’s decision to keep interest rates unchanged at the July FOMC (Federal Open Market Committee) meeting. Williams stated, “At the end of the last FOMC meeting, rates were in a very good place,” striking a balance between the dual central bank mandates of full employment and price stability. “We are now gathering a lot of data and must reassess this,” he further said.

In contrast to Williams’ relatively moderate comments, Fed Governor Michael Barr warned that inflation has stayed above target for more than five years, creating a risk that price pressures become entrenched. He said he is prepared to support further rate hikes if U.S. inflation fails to ease further. As a Fed Governor, Barr also has permanent voting rights; therefore, his policy stance is a key reference for the market to gauge the future interest rate path. His latest remarks suggest that, if inflation continues to linger above the Fed’s target, he does not rule out tightening monetary policy once again.

After holding rates steady for five consecutive meetings this year, the Fed will convene the next FOMC meeting from September 15 to 16. Following Fed Chair Waller’s hawkish signals at the Jackson Hole Global Central Bank Annual Symposium last Friday, market expectations for a Fed rate hike this month have surged. CME’s “FedWatch” tool shows the market currently sees a 66% probability of a Fed rate hike this month, up from 38% last week.

In addition, further escalation in the Middle East has also reinforced market expectations for a Fed rate hike in September. On September 1, local time, the U.S. military launched a new round of airstrikes targeting Iran’s Islamic Revolutionary Guard near southern Iran and the Strait of Hormuz. This was the second strike on Iran within three days after more than a month of military calm, moving the prior U.S.-Iran standoff—which had shifted toward blockade, sanctions, and negotiations—back onto a military track.

Iran’s Islamic Revolutionary Guard claimed that, in response to the U.S. strike on southern Iran the previous night, Iran launched heavy ballistic missiles at a U.S. Marine Corps base near the Jordanian port city of Aqaba, resulting in “a large number of U.S. soldiers killed.” In a statement, the Revolutionary Guard added that “several key facilities and armed helicopters were destroyed,” and that Iran’s retaliation is still ongoing.

Markets are therefore concerned that, if military conflict between the U.S. and Iran further escalates, one of the world’s most critical energy shipping lanes—the Strait of Hormuz—could be disrupted, affecting oil supply and transportation, and pushing global energy prices higher. This would, in turn, exacerbate U.S. inflation risks, forcing the Fed to maintain an even tighter monetary policy stance.

Although expectations for a Fed rate hike this month have risen sharply, some analysts believe that market bets on rate hikes may have moved too quickly. Before the Fed makes a final decision, a batch of key economic data will be released, and there is not yet a clear consensus that the current inflation and employment readings create an urgent case for raising rates.

Among these, the labor market will be one of the most important indicators to observe. U.S. nonfarm payroll data have now shown weakness for three consecutive months. If the nonfarm payroll figures for August, released this week, continue to weaken, this will further undermine the Fed’s reason to tighten policy immediately.

Inflation data is also critical. In July, the U.S. PCE price index rose 3.7% year-on-year, while core PCE rose 3.3%. However, the Dallas Fed’s metric, which excludes extreme price volatility, was just 2.3%, approaching the 2% policy target. Before September’s meeting, the Fed will also receive a series of data, including CPI, PPI, and employment figures. As long as there are clear signs of cooling among these, the current rate hike pricing may quickly retreat.

Regarding the outlook for Fed rate hikes, Société Générale expects the Fed will start raising rates in September, as persistent inflation and an improving labor market are pushing policymakers toward a more hawkish stance. According to the latest report from Chief U.S. Economist Stephen Gallagher at Société Générale, the bank now forecasts that the Fed will raise rates by 25 basis points at both the September and December meetings, and again in March 2027. However, the report notes that there is relatively high uncertainty around the final rate hike.

By contrast, Goldman Sachs is betting that Waller’s hawkish rhetoric will not be matched by hawkish data, so their base case remains that the Fed will hold steady. In a client note, Goldman’s Chief Economist Jan Hatzius said that Waller’s speech at Jackson Hole was his most hawkish appearance since becoming Board Chair, but he believes that a mere shift in tone is unlikely to trigger a rate hike next month.

Hatzius noted that Waller directly addressed a recent series of encouraging inflation reports; while acknowledging that this summer’s PCE and CPI data were better than expected, Waller argued that these data have not yet indicated any substantial improvement in underlying price trends. Hatzius pointed out that this opens the door to a September rate hike, but such action will only occur if the upcoming August CPI and PPI data significantly exceed expectations. Goldman’s internal forecasts suggest this threshold will not be breached. Hatzius said the bank continues to expect core CPI and core PCE inflation in August to come in around 0.2%, a pace insufficient to justify the kind of policy response implied by Waller’s rhetoric.