Powell's Signal: A Soft Landing... Off a Cliff?

Powell’s September Signal: A Dovish Pivot or a Dangerous Gamble?

In a closely watched speech at Jackson Hole, Powell acknowledged a “shifting balance of risks,” notably a slowing labor market, and opened the door to a potential rate reduction as soon as September.

But beneath the surface of his cautiously dovish tone lies a more complicated macroeconomic terrain—one riddled with inflationary signals, fiscal vulnerabilities, and rising uncertainty. The question is no longer "Will the Fed cut?" but rather: "Should they?"

A Signal of Caution, Not Panic

In his address, Powell stopped short of making a firm commitment but emphasized that the Fed’s restrictive stance may need adjustment. With job growth slowing and risks to employment rising, Powell said: “This unusual situation suggests that downside risks to employment are rising. And if those risks materialize, they can do so quickly.”

Yet while the labor market is cooling, inflation is not convincingly under control. Month-over-month Consumer Price Index (CPI) readings have remained elevated through 2024 and into mid-2025.

This CPI chart clearly shows that monthly inflation has re-accelerated, with several months posting readings above 0.4%. If sustained, these levels compound to 5–6% annual inflation, well above the Fed's 2% target.

Despite this, Powell now leans toward preemptive easing—suggesting a pivot from the more hawkish posture held throughout 2023 and early 2024.

Game Theory and the Breakdown of Fed Signaling

The Fed's interest rate decisions are not just about economics—they are about signaling . In a classic game-theory framework, the Fed (signal sender) uses interest rate changes to influence the market’s inflation expectations and behavior.

However, Powell’s September pivot may reflect a breakdown in that signaling mechanism . As shown in the Economic Policy Uncertainty Index, 2025 has seen spikes in volatility, largely driven by mixed signals from fiscal and monetary authorities. This uncertainty is dangerous. When the Fed signals a rate cut even as inflation expectations double...

...it introduces asymmetric information into the system. The market is now being asked to interpret whether the Fed is seeing something hidden in the labor data—or whether political pressure is compromising policy objectivity.

As inflation expectations jump from ~3% to over 6%, it becomes clear: the Fed’s signal is being drowned out.

M2 and the Monetary Overhang

Adding fuel to the fire is the explosion of the U.S. money supply . M2 has now reached a new all-time high, rebounding sharply after a temporary contraction in 2022–2023.

This growth in M2 is not benign. It suggests that liquidity is back on the rise, which, when paired with rate cuts, can create inflationary feedback loops. Historically, M2 growth has led inflation by several quarters. The Fed’s apparent willingness to cut rates while M2 is surging may result in policy pro-cyclicality, feeding inflation at the worst possible time.

Fiscal Backdrop: The Deficit Doesn’t Lie

HeadiThe United States is still running massive fiscal deficits , even in non-recessionary conditions. The budget deficit in 2024 is projected at $1.8 trillion, or 6.3% of GDP—levels typically seen during deep recessions.

This is problematic. Fiscal and monetary policy are now working at cross-purposes. Rate cuts in the context of a structurally high deficit and expanding M2 increase the risk of runaway inflation. The U.S. is effectively trying to stimulate an economy that’s already flush with cash.

Moreover, calls for even more aggressive cuts—particularly from former President Donald Trump, who has publicly advocated for a 1% interest rate—only deepen the disconnect between fundamentals and policy direction.

The gap between Powell’s current rate and Trump’s desired target is wide—and closing that gap too fast could ignite the very inflation the Fed claims to control.ng

The Tariff Time Bomb

Tariffs add another layer of complexity. Trump’s proposed and partially implemented import tariffs are already being priced into supply chains, raising production costs and ultimately consumer prices.

The spike in 2025 tariffs threatens to create cost-push inflation, regardless of monetary policy. Powell himself acknowledged that these effects may not be “all at once” but will continue to ripple through supply chains over time.

Cutting rates in this context—while tariffs are simultaneously boosting input prices—could reinforce inflationary dynamics and undermine Fed credibility further.

Labor Market Weakness vs. Structural Supply Constraints

Powell’s primary justification for a potential cut is a weakening labor market. However, he also acknowledges that part of this slowdown may be due to structural supply-side issues, like immigration crackdowns and demographic trends.

This is not a cyclical decline that rate cuts can fix. In fact, monetary easing in response to structural labor constraints is unlikely to improve hiring and may instead stoke wage inflation.

If the Fed mistakenly interprets structural issues as cyclical ones, its policy response could misfire—again worsening inflation without improving employment.

Investor Euphoria: A Dangerous Misread

Following Powell’s speech, stock markets soared. The S&P 500 gained 1.6%, the Nasdaq rose 2%, and the Dow jumped nearly 2%.

But this rally may reflect misplaced optimism. The chart above shows that only 27.3% of Private Equity (PE) Sponsors still believe in a soft landing. In fact, 45.5% of them think a recession is already underway—highlighting the disconnect between market sentiment and on-the-ground fundamentals.

Investment bankers and corporate strategists are more evenly split, but the growing divergence in expectations shows that there is no consensus on where the economy is headed. In such a fragmented environment, Powell’s signal—though well-intentioned—may be interpreted very differently by different stakeholders.

Policy Crossroads: Why Cutting Too Deep is a Risk

The danger here is not in a small rate cut. A 25-basis-point move in September may be a reasonable recalibration given deteriorating labor data. The danger lies in a wholesale pivot toward aggressive easing in the style advocated by Trump.

Such a pivot would:

• Reduce real interest rates even further
  

• Fuel monetary expansion via higher M2
  

• Fail to address supply-side constraints (e.g. labor and trade)
  

• Accelerate inflation expectations and CPI

The CPI data shows we are already seeing renewed price pressures. Cutting rates too sharply would not just miss the inflation target—it would slam through it in the wrong direction.

Conclusion: Is the Fed’s Signal Still Credible?

In signaling a September rate cut, Powell is attempting a delicate balancing act: protecting a fragile labor market without fueling inflation. But the macroeconomic fundamentals do not justify deep cuts:

• M2 is at record highs
  

• The fiscal deficit is persistently large
  

• Tariffs are raising production costs
  

• Inflation expectations are rising
  

• CPI prints are re-accelerating
  

In game theory terms, the Fed’s signal may no longer be credible. If market participants begin to believe that rate cuts are politically motivated or economically unjustified, inflation expectations could become unanchored—and at that point, regaining control would be much harder.

The Fed’s independence, reputation, and signaling capacity are all on the line.

For now, Powell must proceed carefully. A modest cut may be warranted. But to go too far, too fast—especially under political pressure—would be to invite another inflation cycle, and potentially lose the market’s trust for good.

Sources & References

Angeletos, Hellwig, Pavas. (2006). Signaling in a Global Game: Coordination and Policy Traps. https://economics.mit.edu/sites/default/files/inline-files/signialling%20in%20a%20global%20game.pdf  

CNBC. (2025). Powell indicates conditions ‘may warrant’ interest rate cuts as Fed proceeds ‘carefully ’. https://www.cnbc.com/2025/08/22/powell-indicates-conditions-may-warrant-interest-rate-cuts-as-fed-proceeds-carefully.html  

Denti. (2021). Costly monitoring in signaling games. https://economics.sas.upenn.edu/system/files/2022-08/Denti%20Paper.pdf  

Kaya. (2005). Repeated Signaling Games. http://www.econ.ucla.edu/sboard/teaching/shop/kaya.pdf  

NBC. (2025). Stocks climb as investors bet on rate cut following Jerome Powell speech . https://www.nbcnews.com/business/markets/investors-react-to-rising-hopes-of-federal-reserve-interest-rate-cut-rcna226647  

NY Times. (2025). Powell Sends Strongest Signal Yet That Interest Rate Cuts Are Coming . https://www.nytimes.com/2025/08/22/business/powell-speech-jackson-hole-fed-inflation.html