Since President Trump’s surprise overhaul of U.S. trade policy in April, speculation about the economic and inflationary fallout has dominated headlines. Yet amid the shifting sands of tariffs, fiscal uncertainty, and volatile sentiment, one pillar of macro stability has quietly held firm: Federal Reserve policy. While hardly a sign of confidence, the Fed’s inaction has become one of the few constants in an increasingly unpredictable landscape.
Markets continue to assign high odds that the central bank will hold rates steady at this week’s Federal Open Market Committee (FOMC) meeting, with little change expected for July either. The consensus points to a potential rate cut in September, though given today’s rapidly changing conditions, such forecasts come with major caveats.
The policy-sensitive 2-year yield remains a closely watched barometer of rate expectations. Currently trading just below the Fed’s 4.33% effective funds rate, the market continues to price in easing over the next year, with expectations pointing to roughly 100 basis points of cuts, bringing the fed funds target range to 3.25%–3.50% by mid-2026.
At face value, this rate path implies a spread of approximately 110 to 115 basis points between the 2-year and the current 10-year yield, which sits around 4.40%. However, when adjusting for the 10-year SOFR swap spread—which brings the 10-year rate closer to 4.00%—the true curve flattens considerably, shrinking to around 55 basis points. That narrows the room for rates to fall further without a more aggressive pivot from the Fed.
Could yields drift lower? Perhaps modestly—a 25-basis-point decline may be achievable under current assumptions. But for a material downward move in long-dated yields, the Fed would need to cut more than the market currently expects.
Fed officials, however, have consistently pushed back on the prospect of near-term cuts. “There is a great deal of uncertainty out there,” wrote Atlanta Fed President Raphael Bostic, emphasizing that a patient approach is warranted. “We have space to wait and see how the heightened uncertainty affects employment and prices.”
At the core of the Fed’s dilemma is a policy fork: Do tariffs spark inflation or suppress growth? If tariffs push prices higher, rate hikes might be needed. If they weigh more heavily on consumption and output, cuts could be in order. A third, more complex scenario—stagflation, where slower growth coexists with higher inflation—could validate the Fed’s current policy of holding steady.
Some data supports the wait-and-see approach. Consumer inflation expectations have eased, with the New York Fed’s latest survey showing year-ahead expectations falling to 3.2%, though still above the 2% target. Actual inflation data is mixed: Core CPI remains elevated at 2.8% year-over-year, keeping policymakers cautious. Market-based inflation expectations, such as the 5-year breakeven rate, hover around 2.38%, a moderate level that’s trended upward in recent weeks.
President Trump continues to pressure the Fed for cuts, but the central bank appears determined to wait for clearer economic signals. With tariff policies evolving rapidly and inflation data sending mixed messages, rushing to action may prove premature.
Meanwhile, economic growth is showing signs of softening. The Dallas Fed’s Weekly Economic Index has declined through late May, hinting at broader deceleration. A large-scale spending bill under consideration in the Senate could further cloud the inflation picture if passed, though political gridlock may limit its impact—potentially a favorable outcome for bond markets.
In sum, the Fed’s inaction may be uninspiring, but in today’s environment, cautious stability may be the most prudent course. With inflation and growth risks pulling in opposite directions—and tariff policy a moving target—holding steady remains a strategic choice, albeit a risky one.
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