Fed Looks To Summer Rate Cuts But The Motivation May Have Shifted

The logic for potential interest rate cuts in 2025 may be changing as some early recession indicators pick up while disinflation remains possible. Current expectations are that the Federal Open Market Committee may cut again in May or June. Entering 2025, markets anticipated that inflation might trend closer to the FOMC’s 2% annual target and policymakers would patiently wait for that before cutting interest rates. That’s still a probable outcome, but now the FOMC might consider cutting rates in response to economic weakness, rather than cooling inflation.

Heightened Economic Uncertainty Adds Risk

Federal Reserve Chair Jerome Powell recently sounded a touch more cautious on the economy. He said, “Recent indicators point to a possible moderation in consumer spending relative to the rapid growth rate over the second half of 2024,” at a speech in Chicago on March 7. Powell continued, “further, recent surveys of households and businesses point to heightened uncertainty about the economic outlook. It remains to be seen how these developments might affect future spending and investment. Sentiment readings have not been a good predictor of consumption growth in recent years. We continue to carefully monitor a variety of indicators of household and business spending.” Overall this is not a major economic concern from the Fed chair, but it is less optimistic on the economy than recent statements.

Echoing this perspective is a recent spike in 2025 inflation risk from prediction market site Kalshi. Kalshi is forecasting that the most likely outcome is that a 2025 recession is avoided, but that inflation risks have picked up sharply in recent weeks.

Inflation May Trend Lower

Nonetheless, disinflation could still prompt rate cuts, Powell said, “The path to sustainably returning inflation to our target has been bumpy, and we expect that to continue. We see ongoing progress in categories that remain elevated, such as housing services and the market-based components of non-housing services. Inflation can be volatile month-to-month, and we do not overreact to one or two readings that are higher or lower than anticipated.” The next Consumer Price Index report will come on March 12. Expectations are for some disinflation, but even so a March interest rate cut is viewed as extremely unlikely.

Next Interest Rate Cut Expected In May or June

Due to two potential motivations for interest rate cuts in terms of potentially cooling inflation and heightened risk of economic weakness, markets see roughly an even chance of an interest rate cut on May 7. If not, a cut is more likely than not on June 18. That’s according to the CME FedWatch Tool, which measures the implied expectations of fixed income markets.

What To Expect

Markets forecast lower interest rates in 2025. However, the economic uncertainty has increased. That’s in part because of the evolving scope of tariffs and government spending cuts, with both not fully reflected in recent economic reports given their recent occurrence.

With two possible motivations to cut rates, interest rate cuts are perhaps now a little more probable in the view of markets. Nonetheless, upcoming economic data will be important for two reasons: first, in determining if economic softness becomes more of a trend rather than a risk that some consumers and businesses are worried about; and second in revealing if expected disinflation plays out. The FOMC now has two potential paths to cutting interest rates, depending on what economic data holds.