May 2025 Fed & Rates Call Update

Shifting our Fed call to July & increasing cuts, as the longer they wait, the more they’ll need to do 

• Latest Macro Musing: After all of the recent policy-induced volatility, we are in the data vortex period where it’s hard to assess the true health of the economy. What is further astounding is how quickly markets move on in this environment. However, we still believe that the damage has been done after the US tariff shock. These gyrations have only likely worsened the already weakening trends that were in place coming into 2025. Thus, we do not think that the risk rebound has changed the medium-term macro outlook. Let’s not forget financial conditions can quickly change—the saying goes “easy come, easy go” (and then what, the consumer will retrench). In the actual data, we have had very little inflation to fear and the jobs data remains mixed. Yet short of a tightening of financial conditions (i.e. unwind of all of the recent risk market gains), there is likely not enough time or data between now and June for the Fed to be convinced to cut.
• Fed Rate Path Implications: We believe the longer the Fed waits, the more they are passively tightening conditions, yet as with all things, it’s not what they should do but what they will do. So, we have pushed back our next cut to July (from June) but increased the total amount of 25bp cuts to 4 in 2025. We are compressing rate cuts to take place in the second half of this year. We believe the Fed will keep 2 cuts in the June SEPs and then increase that to 3 cuts in the September SEP as the unemployment rate goes above 4.4%. In our view, July is a good restarting point for cuts, as it’s after the first 90-day tariff extension and we may also have a budget deal. It’s also before Jackson hole and it would be a long wait until September to cut. And again, we expect data to worsen over this period. If the Fed were to skip July, they run the risk of a 2024 repeat, i.e. 50bps cut in September and maybe October too. Overall, the Fed has a chance to get to neutral later this year and avoid having to cut under it.
• US Rates Forecasts: We still believe that the neutral rate is somewhere in the range of 3.00-3.50%, where the longer the Fed waits, the more they need to do. For now, the bond market is under pressure due to fiscal and foreign capital outflow fears. However, if the Fed has another policy error by waiting too long, the bond market will sniff it out as the economy weakens, and it will start to rally over the course of the summer (especially in the front-end). Given that we have had a bull/bear steepener stance since post-election, we only made minor tweaks to our term rate forecasts (see table) and continue to advocate buying dips in 2s while expecting the backend of the curve (5s and out) to lag in any rally due to inflationary/debt dynamic concerns.