April 16, 2025: Rate Cut Probabilities Skyrocket
As we alluded to in this space last week, the Federal Open Market Committee (FOMC) currently finds itself in a precarious position. While often overlooked, recall the FOMC has a dual mandate: promoting maximum employment and maintaining price stability. The inflation spike of 2022 –
which saw the Consumer Price Index peaking at 9.1% in June 2022 and Core CPI at 6.6% three months – provides a fitting example of just how difficult maintaining but one side of the mandate is, let alone both sides. Unfortunately, the FOMC and Fed Chair Jay Powell’s mandate just received a dose of bad medicine on each side of their mandate, courtesy of the US Administration’s tariff policy.
First, let us take the pulse of each side of the FOMC mandate. On the prices (inflation) front, it is easy to appreciate the amount of time that has passed between the inflation heyday of summer 2022 and now, but it bears mentioning that the most recent reading of the core PCE deflator – the FOMC’s preferred inflation measure – currently sits at 2.8%, or 80 basis points above the 2% inflation target, a level last breached a full three years ago. While core PCE continues to trend downward, the home stretch to 2% is considered perhaps the most difficult leg of the race. Meanwhile, the labor markets have provided sustained multi-year strength, with the current unemployment rate registering 4.2% (versus a 50-year average above 6%), with a healthy balance between labor supply and demand restored (following the severe distortion in job openings following the COVID pandemic). While projected to tick higher into the back half of 2025, the unemployment rate is not currently forecasted to broach the 5% level this year.
However, the tariffs announced in the Rose Garden on April 2 effectively serve as a one-two punch to each side of the dual mandate. As we witnessed firsthand, financial markets reacted in horror to the news, sending volatility soaring; equities, fixed income, and commodity price action alike all reflected fears of slowing global growth. Concurrently, economists are forecasting a material rise in costs from the tariff nuclear fallout, from not only the tariffs themselves but also the knock-on effect and disruptions caused throughout the value chain (and specifically the heightened risk of supply shocks). In short, slowing (or negative) growth would destroy maximum employment ambitions, while a bump in prices (whether transitory or not) makes the home stretch of the 2% inflation target that much more perilous. Take it from Fed Chair Powell himself (emphasis is mine): “…[t]he same is likely to be true of the economic effects, which will include higher inflation and slower growth.” Insult, meet injury.
What is the FOMC to do? In the latest Statement of Economic Projections (more commonly known as the “dot plot), the median rate forecast implied two quarter-point interest rate cuts in 2025, but just barely: four FOMC members projected just one cut this year, while four more see none. Conversely, Fed Fund Futures are currently pricing in 85 basis points of interest rate cuts remaining in 2025, suggesting three or four cuts this year…while in the hysteria of last week, rate probabilities flirted with nearly five cuts in 2025, albeit temporarily. With the tariff news drip seemingly resetting the scale on a near-daily basis, the situation is fluid (to say the least) and subject to staleness. However, should the current conditions broadly hold, FOMC meetings would likely be considered “live” (as in, present a material chance of a rate cut) as soon as the June or July meetings of this year.
Source: CME Group
