Fed Note: July 30, 2025

At the late July meeting, the U.S. Federal Reserve Open Market Committee voted to keep the Fed funds rate unchanged at the current range of 4.25-4.50%. However, there were two dissents (Gov. Waller and Gov. Bowman, who both preferred a quarter-percent cut). Two dissents are quite unusual, and haven’t been seen since Dec. 1993, although they are quite common in the meetings of other central banks, such as the notable example of the Bank of England, where split decisions are common.

CME Fed funds futures had anticipated today’s lack of action for weeks, echoed by Fed members in their routine speaking circuits (their own opinions aside). While the Fed hasn’t adjusted policy yet in 2025, the rest of the year shows odds of a September cut at over 50%, steady in October, and another cut in December, bringing the year-end Fed funds rate to 3.75-4.00%. For 2026, the base case points to two more cuts, bringing that year-end rate to 3.25-3.50%. The pace continues to assume ‘normalization’ cuts toward the Fed’s long-term rate estimate of 3.00%, as opposed to more drastic cuts that would be needed in combating a sharper downturn. It was only back in early April that markets assumed up to 4-5 cuts this year, due to trade-related economic distress.

Economy. The first estimate of 2nd quarter U.S. GDP growth just came out this morning at 3.0% (the Atlanta Fed GDPNow indicator was close, having it pegged at 2.9%). Q2 included gains in personal consumption and capex, as well as a substantial reversal upward for net exports (contributing five percentage points to the overall number) and a reversal downward for inventories. Much of the Q2 data offset the sharply negative numbers for Q1, as companies had front-loaded their import purchases before April to avoid expected tariffs. Combined, the Q1+Q2 result for the first half of the year is really a wash, showing trend-like growth overall, but not providing a trove of meaningful new information. Looking ahead, initial broad Q3 and Q4 estimates each lie around 1.0%, give or take a few tenths of a percent. Consequently, recession odds have risen a bit, given that slower growth levels provide less ‘buffer’ from any further slowing generally and potential unexpected shocks. Though, a sharp downturn doesn’t appear to be a base case, especially now that tariff rates don’t appear to be as high as feared and policy uncertainty is fading.

Inflation. For June, headline CPI rose 2.7% over the trailing 12 months, while core CPI ex-food and energy was up 2.9%, and core PCE for May continued to run above-target at 2.7%. After a period of slow deceleration toward normal, official inflation measures have ramped up a bit again. Tariffs aren’t entirely to blame, with volatile food and energy prices contributing, as well as persistence in shelter (at a 4% or so year-over-year rate), and areas like medical, tuition/childcare, car insurance, and car repair remain sticky. In fact, 10-year U.S. Treasury inflation breakevens have risen from 2.2% in April back up to 2.4%, reflecting these expectations as well.

FOMC members appear to be wrestling with the potential impacts of tariffs, which, at least at this point, have not shown high flow-through into official price readings. This doesn’t mean effects won’t emerge eventually, and a variety of economists have raised estimates for CPI and PCE upwards by around an annualized pace of approximately 0.5-1.5% later this year and into 2026. While a surge of ongoing inflation isn’t expected, the higher CPI/PCE rates would reflect a one-time boost to prices. However, more precise data remains in flux, dependent on tariff rate negotiations, product substitution effects, not to mention how much of the total tariff is absorbed by importers and manufacturers, as opposed to being passed through to consumers. (For the latter, per company earnings calls, it appears to be at least a decent percentage has been passed through, but not as much as some may have expected, as firms may feel they can absorb a tariff hit for at least a short stretch.) Nothing about higher prices is reassuring for consumers, many of whom view rates of inflation growth vs. higher price levels as indistinguishable and equally punishing.

Employment. Labor data doesn’t appear to have changed much on the surface but has softened at the edges. The unemployment rate remains low at 4.1%, while continuing jobless claims have inched up and job openings have moved lower, but more dramatic data such as layoffs don’t appear to be rising at this point. This represents a labor market that’s balanced, but also cautious, where changes in tariffs/trade and immigration have made some employers more thoughtful in making moves. Softening here may be the ultimate reason the Fed begins to cut rates again, other than for their normalization case, but the data isn’t weak enough to warrant a faster cutting speed.

The Federal Reserve, and Chair Powell in particular, have gotten quite a bit of flak from the U.S. administration for keeping interest rates high for ‘too long,’ as well as more recently from an expensive headquarters remodeling project. Threats of a Powell firing have continued, but also walked back each time, perhaps serving as a ‘hint’ to coerce Powell to resign before the end of his term in May 2026. Then again, a new Fed Chair is no guarantee of a more dovish policy, as the other voting members would remain in place. In fact, threats may be counterproductive insofar as markets are concerned, as challenges to the Fed’s independence could generate an atmosphere of greater policy uncertainty and undesired political influence that runs the risk of driving up U.S. Treasury rates at the longer-end of the yield curve—defeating the purpose. (Whether the Fed has ever actually been fully independent of political influences remains a matter of debate, with a variety of forces having impacted Fed decisions and personnel over its century of existence.) As has been the case for perhaps as long as recorded history, politicians tend to prefer lower rates not only to ‘encourage’ economic growth through reduced borrowing costs, but perhaps even more so to ease the burden of government interest payments. The latter have steadily risen as a percentage of U.S. GDP, keeping the heavily-criticized annual deficits elevated, and potentially ‘crowding out’ other spending priorities. Some economists look to an interesting comparison of a nation’s spending on interest versus that on defense as a bellwether of future stress—and U.S. levels are entering the trouble zone. Then again, we’ve been here before, albeit not with debt at such a high percentage relative to the overall size of the economy.

Fiscal concerns aside, one might call this a boring year for monetary policy. Since many investors are prone to feel a need to ‘do something,’ inaction has generated some questions about the Fed not moving faster. Their reason for staying put appears to be the balance of risks, which they’ve noted quite a few times in public comments. Keeping policy a bit tighter would appear appropriate in the face of obvious inflation risks (and tariffs, where the understood impact on inflation is certainly higher); at the same time, a slowing economy and labor market (if these indeed continue to slow) would be a case for cutting rates. Such a sandwiched position between their two mandates isn’t enviable, but things out there could be far worse. In fact, all considering, the economy has held up well, and steady policy reflects that.

Ryan M. Long, CFA

Director of Investments

FocusPoint Solutions, Inc.

Sources: CME Group, Federal Reserve Bank, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, FocusPoint Solutions calculations.

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Sources: Ryan M. Long, CFA; Director of Investments; FocusPoint Solutions, Inc.

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