What to Expect from the Fed: When Will Rate Cuts Begin?
The Fed is widely expected to hold rates steady at today’s meeting. But the key question on the market’s mind remains: when will the easing cycle begin? Inflation is cooling, growth is slowing, but policymakers remain cautious. In this note, we explore two potential scenarios - one with the first cut in July, the other with a delay until autumn.
Macroeconomic Landscape: Inflation, Employment, and the Consumer
The Federal Reserve continues to make decisions based on incoming data. In this note, we assess the current state of key indicators - inflation dynamics, labor market conditions, and consumer behavior - in the context of their impact on Fed policy.
Inflation: From Relief to Renewed Risk
In the first half of 2025, inflation in the U.S. eased significantly, nearing the Fed's 2% target. March CPI came in at 2.4% YoY - the lowest level since 2020 and a notable deceleration from February’s 2.8%. Core inflation (excluding food and energy) also slowed, though it remains slightly elevated - estimated near ~3% YoY (Core PCE at ~2.8%).
This disinflationary trend allowed policymakers to declare that the inflation target was “almost achieved.” President Trump cited this as justification for calling on the Fed to begin easing.
But the picture quickly changed. The April tariff shock fundamentally alters the inflation outlook for the months ahead. The Fed has explicitly warned that the newly imposed tariffs the largest in a century are likely to push prices higher.
Some banks have already revised their forecasts. Julius Baer expects inflation to rise to ~3.5% by the end of 2025 due to tariffs. JPMorgan projects core inflation reaching 4.4% YoY (from ~2.8%) despite slowing growth.
In other words, the U.S. now faces the risk of a stagflationary shift - weakening growth alongside reaccelerating prices. Early warning signs are visible. According to University of Michigan data, 1-year inflation expectations jumped to 6.5% in April - the highest since 1981 (up from 5.0% in March). Long-term (5-year) expectations also rose to 4.4% (historically closer to 3%).
Such a sharp rise in inflation expectations is deeply troubling for the Fed, which has spent decades trying to anchor them. If households and businesses start believing in persistently high inflation, it risks becoming self-fulfilling - accelerating purchases and wage demands.
While actual price indices remain contained (April CPI likely around 2.5–2.7% YoY), the balance of risks has shifted. A fresh inflation wave, even if triggered by a one-off factor, is now a real possibility. The Fed must remain alert. This is why Powell emphasized the need to distinguish temporary tariff-driven price shocks from structural pressures.
Until that distinction is clear, the Fed is prepared to keep rates elevated - even at the cost of deeper economic cooling.
Labor Market: Cooling, Not Crashing
As of mid-2025, the U.S. labor market is showing signs of gradual softening but not yet a full downturn. Unemployment has risen from 3.5% (2022 lows) to 4.2% and has stabilized at that level. The April jobs report surprised to the upside with +177,000 nonfarm payrolls (vs. ~130k expected).
Hiring has slowed from the post-COVID boom years, but job creation continues. Layoffs remain historically low, with many firms opting to freeze hiring rather than cut headcount. A key signal - job openings - is trending down. The JOLTS vacancy rate dropped to 4.3% in Q1, below the 4.5% threshold cited by Fed officials (e.g., Waller) as a leading indicator of rising unemployment. A year ago, this rate exceeded 6–7%.
Labor market tightness has thus faded. There are now more jobseekers per opening, and wage growth is moderating. Average hourly earnings rose 3.8% YoY in April, down from ~5% a year ago. MoM growth was just 0.2% (vs. 0.3% expected), reflecting a surprisingly benign wage trajectory.
A deceleration in wage growth to 3.5–4% lowers labor cost pressure and eases services inflation - something the Fed has actively sought. The current trend approaches a “Goldilocks” state: cooling without a spike in unemployment.
There are, however, yellow flags. The workweek is shortening slightly. Labor force participation has plateaued, signaling business caution. Initial jobless claims have edged higher (to ~230–250k weekly, NSA), and workers’ confidence is eroding: more Americans now see job loss as likely in the coming year - across all income groups.
This divergence between sentiment and hard data reflects a “vibecession”: when the labor market feels weaker than it looks. Overall, the labor backdrop can be described as “cool, not cold” - with slowing hiring and wages but no mass layoffs.
That’s precisely the Fed’s goal in slowing inflation without triggering a jobs crash. The current balance gives the Fed time: no urgent need to ease, but no risk of wage spirals either.
The Fed is watching one key trigger: unemployment trajectory. A 0.1–0.2 pp MoM increase (above noise) could prompt action. But April’s flat print (+0.0 pp) means the Fed stays patient - for now.
Consumers: Spending Cautiously, Losing Confidence
The American consumer - the backbone of U.S. growth - shows a mixed profile in early 2025. Real household spending continues to grow, albeit more modestly. Q1 PCE data showed +1.8% YoY growth despite a GDP decline - a sign of underlying resilience.
High-frequency data (Visa, Fiserv) confirms that retail activity is slowing, not collapsing. Fiserv estimates retail sales growth fell from ~3.7% YoY in March to 2.76% in April - still positive. Bloomberg card data shows no sharp drops, just softness in discretionary categories (furniture, electronics, travel, dining).
Some of the winter/spring strength may reflect pre-tariff stockpiling of imported goods. Meanwhile, day-to-day spending and services are holding up better.
But confidence has collapsed. The Conference Board’s consumer confidence index dropped to ~86 in April - a 5-year low. The University of Michigan’s sentiment index fell to 52.2 - below 2008 crisis levels. Expectations for future economic conditions have plunged 37% YoY the sharpest quarterly decline since 1990.
Consumers are experiencing a “vibecession”: sentiment says recession, even if data says soft landing. Inflation and job fears dominate surveys. Most households now expect higher unemployment and report worsening personal finances - even among those not directly affected.
This anxiety may stem from media coverage - many respondents echo macro headlines. But why hasn’t spending dropped more?
Several buffers remain:
Pandemic savings cushions are still being drawn down
The job market, while cooling, hasn’t collapsed
Real wages are growing slightly (~3.8% vs. 2.5% inflation)
Credit (cards, personal loans) is still flowing, albeit at high rates
There’s also a lag: consumers often reduce spending only after experiencing income loss. Since mass layoffs haven’t hit yet, cutbacks are selective.
Still, the risks are clear: if expectations turn into action, demand could fall sharply. The Fed monitors consumer indicators closely, as demand ultimately determines inflation’s path.
So far, data supports a “managed slowdown”: rate-sensitive sectors (housing, autos) are cooling, while essentials and services remain stable. This raises hopes of avoiding a consumption-led recession.
But the risk of a “pessimism spiral” remains where low confidence triggers real retrenchment. Especially if tariff-driven inflation cuts real disposable incomes.
The Fed faces a dilemma. On one hand, weaker demand helps reduce inflation. On the other, a collapse in consumption guarantees recession. So far, the Fed isn’t stimulating households high rates still restrict borrowing. But if demand drops too far, pressure to ease policy will mount.
Bottom line: the consumer is the last line of defense. If they falter, the Fed will have to pivot - regardless of inflation. For now, Americans are still spending cautiously. That gives the Fed room to stay focused on inflation without having to rescue demand.
🧭 Scenario 1: First Cut in July
Conditions:
May CPI stabilizes in 2.3–2.5% range
Unemployment climbs to ~4.5–4.6%
Retail sales and capex slow
Political pressure intensifies (Trump demands cuts)
The Fed, more concerned about employment deterioration than lingering inflation, initiates a 25bp cut in July. This is followed by a pause through the summer to assess the impact.
Supported by: Citi, Deutsche Bank
CME FedWatch: ~65% probability of July cut
Political overlay: Fed may act early to assert independence and preempt recession risk
🧭 Scenario 2: Delay Until September
Conditions:
CPI rebounds above 2.7–2.9% due to tariff pass-through
Unemployment remains below 4.4%
Consumer spending holds firm despite poor sentiment
Fed prioritizes anchoring inflation expectations
Powell maintains a “ready but patient” tone. Cuts begin only in September, contingent on clearer signs of weakness.
Supported by: JPMorgan, Bridgewater, Barclays
🏦 Rate Cut Forecasts: What the Street Is Pricing
A sharp divergence in outlooks highlights the uncertainty surrounding Fed policy. Here's a snapshot of major banks and funds:
JPMorgan
Revised forecast after tariff shock: no cuts until September 2025, only one 25bp cut this year
Base case: Fed funds rate drops to ~3.3% by end of Q1 2026
Goldman Sachs
Sees easing starting in July, totaling ~75bp by year-end
Previously expected a June cut, but stronger labor data pushed outlook back a month
Path: 3 cuts of 25bp in July, September, and December → range of 3.50–3.75% by year-end
Citi
Most dovish call: 5 rate cuts (–125bp) beginning June
Forecasts Fed funds rate at 3.00–3.25% by year-end
Barclays
Moderately dovish: two 25bp cuts in July and September
Year-end range: 3.75–4.00%
Morgan Stanley / BofA
Hawkish stance: no cuts in 2025
Fed remains on hold at 4.25–4.50% throughout the year
Bridgewater
Co-CIO Bob Prince sees market optimism on rate cuts as premature
Fed is “off-course” and unlikely to pivot without real economic deterioration
Base case: delayed easing, prolonged stagflation risk
Apollo Global Management
Chief economist Torsten Slok expects just 50bp in cuts during 2025
Year-end target: ~4.0%
Emphasis on “higher for longer” due to sticky inflation and resilient growth
🔮 Market-Implied Path (CME FedWatch)
Current pricing reflects a moderate easing scenario (~3 cuts in 2025), placing futures between the hawkish Fed rhetoric and dovish investor expectations.
This disconnect between markets and the Fed will likely remain a source of volatility. Investors are betting that slowing growth will force the Fed to cut rates as early as summer, while policymakers continue to signal a readiness to hold if inflation doesn't decisively fall to 2%.
The tug-of-war between these two views and the incoming data - will shape the macro narrative for the remainder of the year.