As expected, the Federal Reserve made no change in policy at the July meeting of the Federal Open Market Committee (FOMC). The target range for the federal funds rate—the rate that banks charge each other for overnight loans—was left unchanged at 4.25% to 4.5%, where it has been since December 2024.
There were two dissenting votes however—one from Fed Governor Christopher Waller and one from Fed Governor Michelle Bowman. Both favored a rate cut at the July meeting. Although dissents have not been common in recent years, the majority of the committee still voted to hold steady for now.
Balance-of-risks focus is still on inflation for now
Despite the unchanged policy, the Fed appeared to open the door for a potential rate cut later in the year. The statement accompanying the Fed's meeting continued to characterize the labor market as "solid" but the assessment of the economy's growth rate was downgraded to "moderate" compared to "a solid pace." The description of inflation remained unchanged at "somewhat elevated."
We continue to believe that there will be enough evidence to support a decision to ease policy by the September meeting. By then, we expect to see further moderation in economic growth and enough weakness in the labor market to warrant a rate cut. The pace of consumer spending has already slowed, growing just 1.4% in the second quarter and averaging just 1.0% year to date. Real final sales to domestic purchasers—a reading that strips out the volatility of trade and inventories—grew at a sluggish 1.2% in the most recent quarter.
The pace of consumer spending has slowed
Source: Bloomberg. Quarterly data from 6/30/2015 to 6/30/2025.
US Final Sales to Private Domestic Purchasers Less Government Consumption Expenditures and Gross Investment (FSDPRSPD Index). Y-axis was truncated for illustrative purposes only. On 6/30/2020 the value was -30.1% and on 9/30/2020 the value was 38.5%.
However, we don't look for a rapid decline in rates, as inflation is likely to remain above the Fed's 2% target until next year due to the impact of tariffs, which are pushing prices for imported goods higher. In his press conference following the meeting, Fed Chair Jerome Powell noted that tariff price increases were just beginning to show up, and that inflation readings likely would move higher in the near term. The committee was hopeful that those price increases will prove "short-lived" but they wanted to ensure that they don't produce a longer-turn rise in inflation or inflation expectations.
Recent data from the Job Openings and Labor Turnover Survey (JOLTS) suggest that the labor market is languishing as hiring slows. The unemployment rate has remained low because there haven't been widespread layoffs, but the trends suggest a softening tone. If that continues, we would expect the Fed to respond with a rate cut even if the inflation readings remain above target. The assumption would be that slower growth will pull inflation lower longer term.
Job openings have slowed
Source: Bloomberg. Monthly data from 6/30/2015 to 6/30/2025.
U.S. Job Openings By Industry Total SA (JOLTTOL Index) and U.S. Unemployed Workers Total in Labor Force SA (USUETOT Index).
Given the potential for inflation to be above the 2% target for quite some time, the Fed will likely take a cautious approach to cutting rates and the ending rate may be higher in this cycle than previously estimated. A terminal rate of 3% to 3.5% might be the low for this cycle, similar to the median longer-run projection of 3.0% from the Fed's last Summary of Economic Projections.
Treasury yields rose modestly following Powell's comments in the press conference, with short-term yields rising more than long-term yields. The two-year Treasury yield rose five basis points, or 0.5%, with the federal funds futures market pricing in one or two cuts by the end of this year. As we've noted, 10-year Treasury yields have been around 4.35% to 4.40%—near the current federal funds rate—for several months. Longer term, we see room for yields to drop but it will take more evidence of easing inflation pressures to see yields fall.
For investors, today's FOMC meeting does little to change our views. We continue to suggest maintaining an intermediate-term average portfolio duration and focusing on higher-credit-quality bonds.
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