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Markets expect the Federal Open Market Committee to cut rates between one and three times in 2025 from their current level of 4.25% to 4.5%. However, the first cuts may not come until the fall on the market’s current view as tracked by the CME FedWatch Tool.
The FOMC is expected to hold rates steady in June and, most likely, in July, too. That might leave the first cut of the year until September, with perhaps a second cut in December. Nonetheless, despite the predictions of fixed income markets, FOMC officials have largely spoken of a wait and see approach, meaning that the impact of tariffs and other government policies on the economy will ultimately shape interest rate decisions.
Fears of accelerating inflation or slowing growth, which some FOMC policymakers believe are a likely consequence of tariffs, haven’t materialized in reported economic data to this point. That arguably gives the FOMC the opportunity to be patient. For example, the unemployment rate has held in a range of 4.0% to 4.2% for the 12 months to May 2025. Without evidence of a weakening labor market and inflation above target, there is little obvious pressure for interest rate cuts. That said, President Trump has been vocal in calling for interest rate cuts. However, the FOMC’s monetary policy decisions are independent of the President.
Another factor causing relatively restrictive monetary policy for now is that headline inflation is running at 2.4% to May 2025. With more volatile food and energy prices removed, that same figure is 2.8%. This remains above the FOMC’s annual inflation goal of 2%. Provided the job market remains robust, the FOMC may be tempted to wait for prolonged, cooler inflation before dropping interest rates.
For example, Federal Reserve Governor Adriana Kugler said at a speech on June 5. “Progress in lowering inflation toward the Committee’s 2 percent target has slowed some since last summer, even if headline and core inflation have continued to decline. The FOMC’s preferred inflation gauge, based on personal consumption expenditures (PCE), grew at a 2.1 percent annual rate in April. While that is quite close to the FOMC’s target, it was dragged down by a decline in energy prices. Core inflation — which excludes volatile prices for food and energy and is a good guide to future inflation — came in at 2.5 percent, so I do believe that our monetary policy stance, which I view as modestly restrictive, is currently appropriate to achieve and sustain 2 percent inflation over the longer term.” This statement was before the most recent Consumer Price Index report for May, though Kugler’s comments appear to remain relevant as that CPI report was largely as expected.
Even though the jobs market and inflation do not appear to have been impacted by tariffs in recent reports, that could change. Policymakers generally expect tariffs to raise prices to a degree, although how much of any potential cost will be shouldered by importers and exporters relative to consumers remains to be seen. Anecdotal data from statements by major firms implies that price increases from tariffs may be coming in June and July, if so, that won’t have been picked up by reported data yet. Furthermore, the consumer reaction to any potential price increases is unknown, too.
With five FOMC meetings remaining in 2025, any change in interest rates is expected to be weighted towards later in the year. Modest cuts in interest rates are viewed as likely. That assumes, broadly speaking, that job market continues to remain robust, but the FOMC gains are little more confidence that inflation is returning to 2%. There is a chance that tariffs or other government policies change the economic trajectory as weaker survey data signal is possible, but for now that hasn’t been materially evident in reported data. If that remains the case the FOMC may return to cutting interest rates later in 2025. Should the economy unexpectedly weaken, larger and sooner cuts are possible.
