Slowing employment meets tariff inflation, and the Federal Reserve may see its first "three-way split" since 2019.

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A divided Federal Reserve is preparing to implement its first rate cut of the year, but the decision-making process is fraught with contradictions: on one side is a weakening job market, and on the other, inflation risks brought by President Trump’s tariff policies.

Most investors expect the Federal Open Market Committee, which sets interest rates, to announce a 25 basis point rate cut at Wednesday’s policy vote. However, Fed Chair Powell may find himself caught between two opposing forces—on one side, governors advocating for a larger rate cut, and on the other, regional Fed presidents inclined to hold policy steady.

This dilemma could result in the Fed’s first “three-way split” vote since 2019, with opinions simultaneously supporting a rate cut, a larger rate cut, and holding rates steady.

“They’re very likely to get dissenting votes from both directions,” said Vincent Reinhart, former Fed official and current chief economist at BNY Investments. “It indicates that the rationale for action has failed to build sufficient consensus.” Krishna Guha from Evercore ISI also noted, the possibility of a three-way split “signifies that the Committee is under unique pressures right now.”

Tariff inflation risks remain, but jobs data flashes red

The core disagreement between Powell and some regional Fed presidents centers on how to assess the inflationary impact of tariffs. Last month at the Jackson Hole global central banking symposium, Powell said that a slowdown in the job market could be sufficient to offset upward price pressures from Trump’s tariff policies, arguing that any impact tariffs have on prices would be a “one-off shock” the Fed can ignore.

However, some hawkish officials remain skeptical. Officials including Chicago Fed President Austan Goolsbee, Kansas City Fed President Jeff Schmid, and St. Louis Fed President Alberto Musalem believe inflation indexes are still edging higher and have yet to fully reflect the impact of trade policies, while the 4.3% unemployment rate remains low. In their view, it’s too early to ease monetary policy while inflation risks remain.

Meanwhile, dovish voices supporting a more aggressive rate cut are just as hard to ignore. A string of recent weak economic data is their main argument. Jobless claims released last week rose to the highest level since 2021, and the latest nonfarm payroll report showed the first monthly job losses since the COVID-19 pandemic.

These worrying signals may push some officials to advocate for more decisive action. Fed Governor Waller, who is one of the main contenders to succeed Powell as Fed chair next May, may see these data as sufficient grounds for a 50 basis point rate cut. If another Trump ally, Stephen Miran, is confirmed by the Senate as a Fed governor before the September meeting, he too may support a 50 basis point or even larger rate cut.

Political maneuvering: Delicate balance under Trump’s pressure

In addition to economic debate, unique political and institutional pressures also hover over this meeting. Trump’s continued attacks on Powell and the recent firing controversy involving Governor Lisa Cook both test the Fed’s decision-making independence.

Against this backdrop, some analysts believe that dissenting hawkish votes could be politically beneficial for Powell. Krishna Guha of Evercore ISI analyzed:

“It could, to some extent, balance the pressure from Trump and the officials he appointed who are demanding more aggressive rate cuts.”

LHMeyer analyst Derek Tang speculated that Powell might try to strike a “major deal,” hinting at a higher bar for future rate cuts in exchange for hawkish support at this meeting.

The complex economic background and tense political climate also indicate that the Fed’s guidance on its policy path will be highly uncertain.After the meeting, the FOMC will release its latest quarterly economic projections, including the “dot plot” illustrating the views of all 19 voting and non-voting members on growth, inflation, unemployment, and interest rates.

Michael Feroli of JPMorgan said:

“Given the inflation outlook, moderates and hawks within the Committee may be very cautious in committing to a future easing trajectory.”

Vincent Reinhart presented an even more vivid description:

“The economic projections will be the most dispersed we’ve ever seen. The dot plot will look like a giant blank canvas... We’re about to see an ‘ink splash painting.'”

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