The Fed has emphasized the need to wait and see if the weakness in soft data translates into weakness in hard data. They are beholden to trade policy—itself incredibly uncertain—and are now likely to delay further rate cuts until late Q3. Also complicating matters is the ongoing challenges to their independence, which has the potential to undermine monetary policy credibility. In the meantime, investors should prepare for a higher-volatility environment marked by fragile rate expectations, increased market sensitivity to Fed signals, and renewed pressure on the U.S. dollar.
With uncertainty extremely elevated, and with risks of a stagflationary environment—higher unemployment and higher inflation—high as well, the Federal Reserve has been plunged into an almost impossible situation.
The Fed has emphasized the need to wait and see if the weakness in soft data translates into weakness in hard data. Although they are beholden to fiscal and trade policy, it’s unclear whether the current level of tariffs will be sustained, and to what extent they may evolve in the coming months as potential trade deals emerge.
In this situation, it’s likely the Fed sits on its hands. Rate cuts will be required but, increasingly, they will need to wait until late Q3 before the window of opportunity opens, starting with a 25bps cut in September, followed by another in October and then in December.
However, complicating matters, the Fed’s wait-and-see approach potentially opens them to renewed criticism from the Trump administration. Ongoing political jawboning and challenges to Fed independence could undermine the credibility of future monetary policy choices. The Fed’s anchoring effect on interest rates may also be challenged if it is seen as succumbing to the President’s directives.
As a result, while easier monetary policy is likely to emerge eventually, investors should also be prepared to see more bouts of volatility, with longer-term yields and the dollar particularly vulnerable.
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