Risk management

Bottom line

For the first time since last December, the Federal Reserve opted to cut interest rates at its policy-setting meeting on Wednesday, lowering the target range by a quarter point to 4-4.25%. The central bank decided that the recent rapid deterioration in the labor market outweighed the modest uptick in inflation. We and many others had anticipated the move. But the composition of the Fed’s quarterly update of its Summary of Economic Projections (SEP) was slightly surprising. 

Where are rates headed? The Fed telegraphed the potential for two more quarter-point rate cuts this year, in October and December, and one more in each of 2026 and 2027. It kept the longer-run terminal value for the fed funds rate at 3%. We here at Federated Hermes expect a similar trajectory but at a faster pace: five quarter-point cuts by the end of 2026. 

Changes to the SEP The central bank raised its expectations for GDP growth for this year and in each of the next two years, while increasing its estimates for core inflation next year and reducing its forecast for the unemployment rate in each of the next two years. But the shift from the June SEP has raised some eyebrows on Wall Street. 

During Wednesday’s press conference, Fed Chair Jerome Powell rationalized the Fed’s decision to cut rates now as a risk management or insurance rate cut. “There are no risk-free paths now,” Powell said. “It’s not incredibly obvious what to do.” But this flies in the face of its expectations for stronger economic growth and employment, as well as higher inflation next year

GDP discrepancy The Fed thinks GDP will grow this year from 1.4% to 1.6%, compared with growth of 2.8% in 2024. The Fed also raised its 2026 growth estimate from 1.6% to 1.8% and its 2027 forecast from 1.8% to 1.9%. It initiated a 2028 forecast at 1.8%, identical to its longer-run forecast for economic growth.

In contrast, Federated Hermes is forecasting stronger growth of 2.0% this year and 2.8% in 2026. We have a constructive view on consumer spending, which accounts for 70% of GDP. For example, the important Back-to-School season has risen by a strong 4.2% year-over-year (y/y) so far, compared with 2.3% growth last year. We expect an acceleration in corporate capital expenditures this year and next, due to the full-expensing provision in President Trump’s One Big Beautiful Bill Act. With lower interest rates, we expect housing to perk up next year. Finally, Trump’s trade and tariff policies are proving to only be a small drag on economic growth while generating revenue for the government.

Labor market challenges The Fed left its 2025 forecast for unemployment (U-3) unchanged at 4.5% in its new September SEP update, compared with the actual rate of 4.3% in August 2025, a four-year high. By comparison, U-3 was at 4.0% in January 2025 and at a 53-year cycle low of 3.4% in April 2023. The Fed also reduced its previous June forecast of 4.5% unemployment for 2026 to 4.4% in September; it lowered its 2027 estimate from 4.4% to 4.3%; and it initiated a 4.2% estimate in 2028, identical to its longer-run forecast. 

But the recent weakness in the labor market has certainly caught the Fed’s attention and made for its principal justification for cutting rates this week. Over the past four months through August, nonfarm payroll gains have averaged only 27,000 jobs per month, the weakest pace of job creation since the depths of the Covid pandemic. That compares with average monthly payroll gains of 123,000 over the first four months of 2025 and 168,000 during 2024. Moreover, the Labor Department recently released its Quarterly Census of Employment and Wages (measuring the 12-month period through the end of March 2025), which revised job creation down by a sizable, worse-than-expected 911,000 jobs, on top of a negative revision of 818,000 jobs last year.

Darkest before the dawn However, there are three reasons why concern about the labor market may be overblown.

• First, initial weekly jobless claims (a high-frequency leading employment indicator) declined to 231,000 for the week ended September 13 (the survey week for the September payroll report), down from a four-year high of 264,000 claims the prior week. 
• Second, August is historically the quirkiest month of the year for the employment situation. With schools restarting, summer vacations ending and factories retooling plants, there’s a flow of workers moving into and out of jobs temporarily. The data typically gets fixed with revisions in September and October. This August’s report was remarkably weak. But Kevin Hassett, chair of the National Economic Council, predicted that payrolls could be revised up by an estimated 70,000 in coming months. 
• Finally, Trump’s increased deportation of immigrants has clearly impaired the labor market this year. Agriculture, construction, and hospitality are three important industries that have been disproportionately harmed, so we could see a policy course correction in coming months.

Inflation still a concern The Fed left its forecast for core PCE inflation unchanged in 2025 at 3.1% in its new September SEP update, compared with actual core PCE inflation of 2.9% y/y in July 2025. Inflation peaked at a 39-year high of 5.7% y/y in February 2022 and declined to a four-year low of 2.6% in April 2025. The increase over the past three months is likely related to tariffs, which the Fed believes represent a one-time adjustment in prices, rather than the start of another sharp inflationary spike. But the Fed raised its previous forecast for core PCE inflation from 2.4% to 2.6% in 2026; it left its 2027 estimate unchanged at 2.1% in 2027; and it initiated its 2028 forecast at 2.0%, which is also its longer-run inflation objective.

As the Fed turns Part of the ongoing drama of this week’s Fed meeting was the comings and goings of the seven members of the Board of Governors and the 12 regional presidents. Stephen Miran took an unpaid leave of absence from his role as the Chair of the White House’s Council of Economic Advisors to fill out the remainder of Adriana Kugler’s term on the Fed’s Board of Governors (she resigned in July). The Senate confirmed him Monday night. Miran created sparks Wednesday as the sole dissenter, supporting a more aggressive 50-basis point cut this week. Moreover, he is believed to have forecasted a steep drop in the fed funds rate this year to 2.875% — which implies another 1.25% in cuts this year — and to 2.625% next year.

During the presser, Fed Chair Jerome Powell said there was not widespread support for a 50-basis-point cut. Nevertheless, there is an unusually wide dispersion of projected fed funds rates for this year, from a range of Miran’s likely 2.75-3.00% at the low end to 4.50-4.75% at the high end.

Read more about our views and positioning at Capital Markets.

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