Monday 16th June 2025
Back in December, the US Federal Reserve hit pause on its long-anticipated interest rate cutting cycle. Policymakers were waiting for clearer signals on inflation and employment before making their next move. Six months on, we may finally be approaching that point and the next rate cut could arrive sooner than expected.
The Federal Reserve’s main job is to keep inflation under control while supporting maximum employment. If inflation is too high, they raise rates. If the economy is cooling and inflation is tame, they cut rates to stimulate activity.
Since December, inflation has been gradually declining but not quickly enough to justify cutting rates just yet. Meanwhile, the US jobs market has stayed resilient, with unemployment low and hiring fairly strong. That’s kept the Fed in a ‘wait and see’ mode.
Despite widespread pessimism in consumer sentiment surveys, the hard economic data hasn’t shown serious damage from tariffs or cost-of-living pressures. So far, this has allowed the Fed to stay put.
However, there are increasing signs that the US economy may be entering a more fragile phase. Some of the most telling data comes from what’s known as ‘soft data’. These are surveys of businesses and consumers, rather than hard numbers like GDP or payrolls.
This week, the ISM (Institute for Supply Management) Services Index, a key measure of the health of the services sector, fell into contraction territory. That means more businesses are reporting declines than growth.
One complication is the return of trade tariffs under Donald Trump’s economic policy proposals. Tariffs often raise import prices and can contribute to inflation, something the Fed would usually respond to by not cutting rates.
But some policymakers, including Federal Reserve Governor Christopher Waller, argue that the inflation caused by tariffs will be transitory, short-lived and unlikely to drive a lasting increase in inflation expectations.
Waller made a point this week: the Fed should look through this kind of inflation when setting interest rates. As long as inflation expectations remain anchored, meaning investors and businesses believe inflation will stay low in the medium term, the Fed has room to cut rates without risking a spike in prices.
Market data seems to agree. Inflation expectations derived from inflation swaps (a type of financial contract) show that investors don’t expect inflation to take off. That’s a green light for the Fed to act if the labour market shows weakness.
The clearest trigger for rate cuts would be weakness in the job market. Some labour market signals are flashing warnings signs. More people are transitioning from employment to unemployment, or from out-of-work and not looking, to actively job-hunting but unable to find work. These trends often precede broader economic slowdowns.
If today’s official jobs report from the US Department of Labor confirms that picture, the pressure will mount on the Fed to act, possibly as soon as July.
For markets, rate cuts are typically seen as positive, they lower borrowing costs, boost consumer spending, and often lift stock prices.
If the Fed does move to cut rates in July, we could see a rally in bonds and interest-sensitive sectors like real estate and utilities. The pivot may be near.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.
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