Flash Macro: U.S. FOMC

On Wednesday, the Fed cut rates by -25 basis points and changed its forward guidance to reflect an additional rate cut this year (bringing their forecast to three cuts this year, in-line with GMAA’s outlook). The FOMC also released new economic forecasts that showed higher growth, lower unemployment, and faster inflation (Exhibit 2).

Chair Powell’s comments endorsed our view that the Fed needs to cut rates faster, given worsening labor risks but still somewhat sticky inflation concerns. We do not see this balance of risks shifting back towards inflation in 2026, which is why we think the Fed will ultimately cut rates more aggressively than policymakers expect over the next twelve months.

To reflect our evolving outlook, we are tweaking our 10-year target to 4.0% from 4.25-4.5% in 2025; longer-term, we maintain our 4.0% outlook for the 10-year.

Key points from the committee are as follows:

• The Fed is starting to recognize downside risks to employment… Chair Powell acknowledged that “demand for workers has come down sharply,” but that a lack of available workers is helping to prevent layoffs. Keep in mind that unemployment would be closer to five percent if it were not for lower labor market participation, we think, which helps explain why the FOMC’s unemployment forecast moved down despite the Chair’s more cautious tone (Exhibit 3).
• …And they see fewer upside risks to inflation. While the FOMC actually marked up its core inflation forecast for 2026 to 2.6% from 2.4%, we believe this revision reflects what Powell described as a “one-time” goods price increase. Meanwhile, ‘sticky’ inflation components continue to soften (especially housing, as we show in Exhibit 4), which we think will help the Fed ‘look through’ tariff-related inflation when cutting rates.
• The Fed now plans to cut rates back towards neutral, while keeping real rates around one percent in equilibrium for a weaker job market. One can see this in Exhibit 5. The Fed’s forecast shows cuts each year through 2029, at which point they reach a three percent ‘neutral’ rate.
• In practice, however, we think the Fed will ultimately need to ease rates a bit faster than its dot plot suggests. We expect job growth to remain near zero this year, which would typically call for a zero percent real rate (Exhibit 5). We expect the Fed to take rates closer to this zip code in 2026 (i.e., rates just below three percent and inflation in the mid-high two percent range) as we think inflation risks will continue to diminish once we move beyond the initial ‘shock’ of higher tariffs.
• Importantly, this cutting cycle does not mark a reversal in our Regime Change thesis. If anything, Fed cuts amid what remains above-target inflation underscores the structural considerations we have been highlighting around deficits, demographics, geopolitics, and the energy transition. Looking at the details, we still see inflation settling in the mid-two percent range long run, with fed funds settling in the low three percent range. We think that reality will keep bond yields from rallying as much this cycle.