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Posted July 8, 2025 at 10:45 am
Current macro and geopolitical uncertainty make high-confidence forecasting extremely difficult right now. Nevertheless, the case for multiple Fed rate cuts sooner rather than later remains compelling because:
The June summary of economic projections (SEP) maintained a median expectation of two Fed rate cuts this year. However, just a single “dot” now divides the two- versus one-cut scenarios, not to mention that seven of 19 FOMC members anticipate no cuts at all.
The new SEP shows higher inflation and lower growth — and a whole lot more uncertainty about which of these risks should be prioritized.
Despite tariffs and the evolving Middle East situation, we think the Federal Reserve (Fed) should pay more attention to the deteriorating labor market. Because policy works with such long lags, delaying the cuts at this stage would unnecessarily exacerbate recession risks.
We therefore retain our long-standing call for 75 basis points of cuts this year for the following three reasons.
When the Fed last lowered interest rates in December 2024, headline PCE (personal consumption expenditure) inflation was 2.6% y/y and core PCE inflation was 2.9% y/y. By May 2025, the two measures had eased to 2.1% and 2.6% y/y, respectively. In other words, despite inflationary tariff developments, notable further inflation progress has been achieved in the interim.
Yes, inflation will rise in coming months as tariff effects eventually bleed into the data, but the uptick should be modest given offsetting disinflationary forces elsewhere, particularly in shelter, insurance, and discretionary services. With the marginal exception of two months in 2023, the FHFA data shows home price inflation now running at the lowest level since 2012. Various rent inflation metrics suggest some further moderation in this space. Hence, we project core PCE inflation at 2.8% y/y in Q4, below the latest SEP median forecast of 3.1% y/y.
Figure 2: US labor market is loosening visibly
The US unemployment rate has been remarkably stable over the past year, oscillating within an extremely narrow 0.2 percentage point range. It stood at 4.2% from March to May, precisely at the Fed’s presumed equilibrium or NAIRU level (non-accelerating-inflation rate of unemployment).
But with every other labor market indicator out there suggesting broadening erosion, it seems only a matter of time before the unemployment rate starts rising (Figures 2 and 3). In fact, had it not been for an unusually large decline in the labor force participation rate in May, we might have already seen an increase. Why? Because the pace of hiring is slowing and there is some evidence that layoffs are starting to broaden beyond the government sector, where DOGE actions triggered a severe spike in layoffs in February and March.
In the past four months, we’ve recorded three of the four highest private sector layoffs since 2012. It is incredibly important for the Fed to stem this increase if we are to preserve the soft landing and avoid a recession.
We feel strongly that some rate cuts now/soon would not make a difference to the inflation trajectory given inflationary pressures stem from tariffs, not from an accommodative monetary policy. But they could make a big difference in fending off a recession.
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Originally Posted on July 8, 2025 – High uncertainty doesn’t mean indefinite Fed inaction
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