Fed stays on hold amidst ongoing tariff drama

Executive summary

As expected, the Federal Reserve (Fed) held its target federal funds rate steady. Similarly, the pace of the Fed’s balance sheet runoff was unchanged.

Many will focus on the fact that 2 of the 12 voters dissented, wanting instead to lower rates at this meeting. However, both Governors have dissented on policy changes in recent meetings. More broadly, we aren’t concerned about dissenting votes and believe disagreements are a part of healthy debate.

Fed Chair Jerome Powell maintained a disciplined approach during the press conference, with a relatively firmer tone and shorter declarative statements.

The Fed is likely to maintain its current stance for now, with rate cuts expected in September or October. We anticipate a total of 50 basis points (0.50%) of cuts for 2025, though a shorter timeline coupled with protracted tariff negotiations may mean only one cut this year.

What happened

At its July rate-setting meeting, the Federal Open Market Committee (FOMC) maintained its target range for the federal funds rate at 4.25% – 4.50%, holding steady where it’s been since December. However, the vote wasn’t unanimous as two members of the Board of Governors – Governors Bowman and Waller – dissented. Both wanted to lower rates by a quarter point (0.25%) at this meeting.

It will continue its balance sheet reduction (i.e., quantitative tightening, or QT), with monthly caps of $5 billion for U.S. Treasuries and $35 billion for agency mortgage‑backed securities (MBS).

Within the official FOMC statement, policymakers acknowledged that recent data painted a slower picture of economic growth in the first half of 2025. During his press conference, Fed Chair Powell pointed to a pullback in consumer spending as the primary culprit for the cooling in the economy. Conversely, he walked through several labor market indicators that suggest employment and hiring remain on firm ground. Moving forward, the Fed clearly remains in data-dependent mode and is still not fully comfortable with what the ultimate impact of tariffs will be on inflation and the economy. Powell sidestepped specific "what if" questions about his job, including whether he will be fired by President Trump, and when he will leave as Fed Chair. 

Our take

As we expected, the Fed is sitting on the sidelines awaiting more clarity on tariffs. Moreover, the on-again/off-again dynamic of tariffs validates that wait & see mode is appropriate.

The U.S. economy has remained remarkably resilient – even in the face of rapid-fire tariff “deal” announcements, which provide tidy headlines but very few specifics. That breeds further trade policy uncertainty. Similarly, while the recently passed “One Big Beautiful” tax bill introduces greater clarity in tax policy, Congress must also address funding appropriations for the upcoming fiscal year; a failure to do so could lead to a government shutdown.

Alas, this reinforces the continuation of the muddle-through environment—where growth is slowing but not stalling. This has kept the Fed in a holding pattern. We still think the Fed will cut rates by 50 basis points (0.50%) this year, though the timing hinges on the data, especially for inflation. Awaiting more data also suggests that a patch of noisy numbers could punt potential rate cuts later in the year.

Lastly, we applaud Chair Powell for remaining "head down" focused on the data rather than engaging in speculation about his future, which really serves no practical purpose aside from generating news headlines.

The potential risks associated with attempting to remove Chair Powell outweigh the benefits in our view, particularly since Powell’s term concludes in May 2026. However, we believe that the White House will consider an alternative approach regarding Powell's succession. Fed Governor Adriana Kugler’s term is set to expire in January 2026. We expect Powell’s successor to be nominated when Governor Kugler’s term ends in January 2026 and then elevated to become Chair by May 2026. Then, the White House would nominate a new Fed Governor once Powell’s seat is empty. 

Addressing the two dissents

Leading up to this meeting, there was a lot of handwringing about dissents by voters as a signal that there were deep divisions within the Federal Reserve. While many pundits are fixated on the notion that this marked the first time two Fed Governors dissented in 30 years, the reality is that dissenting votes are rather common. In fact, both have dissented on policy changes in recent meetings, Governor Bowman did so last September, and Governor Waller did this past March when he wanted to maintain the pace of QT runoff.

Moreover, pundits are drawing a distinction between Fed Governors and the regional Bank Presidents suggesting that as proof of splintering opinion within the Fed. While there are real differences in the roles and responsibilities, it really doesn’t matter when it comes to policy votes. To wit, each still casts one vote and the majority rules. 

More broadly, we aren’t concerned about dissenting votes and believe disagreements are a part of healthy debate. In truth, we’d be more concerned if there were no debate or dissents, which suggest groupthink. Evidence of ongoing, healthy debate is already apparent within the so-called dot plot, which shows each FOMC member's forecast for the federal funds rate. For example, in the June release the majority of the 19 FOMC members expected two rate cuts this year, but two members penciled in three cuts while nine others saw fewer than two. Furthermore, there hasn’t been unanimity within the dot plots since December 2023. Thus, we aren’t concerned.

Bond market reaction

Since the June FOMC meeting, U.S. Treasury yields have chopped sideways across the yield curve, caught between slightly cooler economic activity and elevated geopolitical tensions versus the uncertain impact of trade policy on inflation and fiscal deficit concerns. For the past four months, the 10-year U.S. Treasury yield has remained in a very tight trading range – roughly 4.2% to 4.6%. Over that span, we have also seen interest rate volatility fall markedly from its peak around the initial tariff rollouts in April. Additionally, global demand for U.S. debt securities has remained very strong, defying the narrative that “foreign investors are shunning American investment.”

U.S. Treasury yields largely went full circle today, initially rising on this morning’s strong print for second quarter gross domestic product (GDP) only to erase that move after the Fed rate decision came with two dissents. However, during his press conference, Fed Chair Powell’s comments hewed closely to the central bank’s data-dependent messaging about how it intends to formulate policy moving forward. This disappointed those traders who had increased bets for a September rate reduction. Market-based odds for a September rate cut fell from 68% to 47%, which recalibrated short-dated U.S. Treasury yields higher. As a result, the 2-year/10-year yield curve flattened, extending a two-week trend.

U.S. interest rates will remain very sensitive to fiscal and trade policy developments along with incoming economic data, particularly with respect to inflation and the labor market. The market’s reactions to these factors may create tactical opportunities to adjust portfolio duration; however, the intermediate portion of the yield curve is still trading near our assessment of fair value. Thus, we continue to recommend a neutral duration posture within a fixed income portfolio relative to intermediate benchmarks. As the Fed rate pause continues, the front-end of the yield curve continues to offer elevated yields with modest interest rate risk for those seeking productive, high-quality alternatives to cash.

Bottom line

The Fed remains on the sidelines with respect to rates, awaiting more data on tariffs and inflation. We still see 50 basis points (0.50%) of Fed rate cuts in 2025, starting in September or October, but wouldn’t rule out only one cut this year.