Fed poised to cut and stop QT

October 24, 2025

The Federal Open Market Committee (FOMC), the policy setting arm of the Federal Reserve, is poised to cut short-term interest rates by another quarter point next week and announce an end to reductions in its balance sheet, known as quantitative tightening or QT. Chairman Jay Powell laid out the Fed’s plans to end QT at a speech on October 14. The decision will come with at least one dissent from newly appointed Governor Stephen Miran, who is on leave from his position in the White House to fulfill the end of a previous Governor’s term that lapses in January 2026.

Miran has pushed hard for more aggressive cuts in short-term rates and dissented in favor of a more aggressive one-half percent cut in September. Back then, seven of nineteen participants in the meeting preferred the Fed to pause their cuts after that meeting. One wayward soul had no cut at the September meeting, which showed up in the Fed’s dot plot for the trajectory of rate cuts for the remainder of this year. Powell was able to corral the cats and keep hawks from dissenting in the other direction at the September meeting.

The labor market was already weak, but hawks made clear that they worried the rise in inflation could have more staying power than one would usually expect from tariffs. The proximity to the pandemic bout of inflation complicated the calculus. The Boston Fed published research on inflation expectations suggesting that they may be becoming unmoored. That ups the risk of a more sustained increase in inflation or worse. We tend to get the inflation we expect.

The Fed’s Beige Book for October revealed signs of stagflation, with some firms engaging in “opportunistic pricing” and sticky service sector inflation. The reduction in competition due to tariffs and rising inequality created fertile ground for price hikes.

The government shutdown is tempering those concerns in the near term and is expected to derail the push by hawks to hold the line. The Fed was willing to risk a recession for 9% inflation; it is less willing to risk a recession for a 3% handle on inflation, some of which will resolve itself, especially in the near term. The debate for 2026 could flare again, depending on how shifts in the Fed’s leadership play out.

The shutdown alone is shaving about 0.2% from real GDP growth per week. Losses are nonlinear; they tend to rise the longer the shutdown lasts. Government workers have been warned to prepare for a shutdown that could last until December.

We usually recoup most of the losses from a shutdown. This one is larger and longer than previous shutdowns, affecting more workers than we saw during the record breaking 35-day shutdown in 2018-2019.

Some 750,000 workers are currently going without pay and that is prior to furloughs of government contractors, who will not be paid in arrears. Part of the military was paid in mid-October, but funds have dried up. The administration has threatened to make more layoffs permanent and freeze funds for Democratic states as part of the shutdown. That would add insult to injury to states that are already feeling the bite from smaller revenues.

Hiring by state and local governments went from a driver to a drag on overall employment gains between 2024 and 2025. September (the data has been gathered but not compiled) has not been released but it is usually the largest month for hiring by state and local governments.

Current losses will add to the 151,000 federal workers who took buyouts earlier in the year and are expected to compound the spillover to local communities. Work done by the Atlanta Fed earlier in the year suggested those losses had significant spillover effects.

The demand and supply of workers have fallen due to a shift in immigration policy. However, it is a good bet that once data collection is restarted – we will lose some data entirely – this period could easily show red ink for the payroll data. That suggests a rise in unemployment, which makes a cut in interest rates easier to justify.

Separately, liquidity in the overnight fed funds market is drying up, which is hurting the transmission of monetary policy via reductions in the fed funds rate. The Fed will stop QT (quantitative tightening), leaving ample reserves in the system to keep the market functioning.

The Fed is widely expected to engage in more balance sheet operations to keep the fed funds market from seizing within the next six months. Any subsequent additions to the Fed’s balance sheet will be offset nearly one for one with reductions in the reserves that banks hold at the Fed. That amount currently tops $3 trillion and is expected to drop to $2.7 trillion as those operations are executed.

The CPI report for September is one of the few reports that was released due to the need to set the cost-of-living adjustment for Social Security in January; it is based off the end of the fiscal year CPI. It revealed a cooler-than-expected increase in inflation which gives the Fed more latitude to look through the rise in inflation at the moment and focus more on shoring up the labor market.

The challenge is whether rate cuts alone can offset the drag on growth due to the shutdown. That seems unlikely. Brace for a chill in consumer spending as we move into the holiday season due to the shutdown, earlier buyouts of federal workers, the spillover effects on government contractors and the margin squeeze due to tariffs.