Did the Fed just add a third mandate?
Central bank waiting for fiscal and geopolitical policy developments to unfold before cutting rates.
Published June 20 2025
Bottom line
Despite a weakening labor market and core inflation perched at a four-year low, the Federal Reserve opted to leave interest rates unchanged for its fourth consecutive FOMC meeting on Wednesday. The Fed cited trepidation related to the eventual outcome of President Trump’s trade and tariff policies and the tax legislation that is currently winding its way through Congress.
An added wildcard is the nascent military conflict in the Middle East between Israel and Iran. Will the US become more fully engaged, will the war be defused shortly or escalate into a nuclear holocaust, and how will a potential surge in the price of crude oil impact nominal inflation? All told, the Fed is concerned that inflation will spike in coming months, which it believes will outweigh the risks associated with rising unemployment and slowing economic growth.
Changes to the SEP The central bank also lowered its expectations for GDP growth for this year and next, while increasing its estimates for inflation and the rate of unemployment in each of the next three years, keeping the upper band of the fed funds rate unchanged at 4.5%.
In its new June update of its quarterly Summary of Economic Projections (SEP), the Fed sharply lowered its estimate for GDP growth this year from 1.7% to 1.4%, compared with actual GDP growth of 2.8% in 2024. The Fed also reduced its 2026 GDP estimate from 1.8% to 1.6% and kept its 2027 forecast unchanged at 1.8%.
The Fed ticked up its 2025 forecast for unemployment (U-3) from 4.4% to 4.5% in its new June update, compared with the actual rate of unemployment of 4.2% in May 2025. It also raised its previous forecasts of 4.3% unemployment for both 2026 and 2027 to 4.5% and 4.4%, respectively.
The Fed also significantly increased its forecast for core PCE inflation in 2025 from 2.8% to 3.1% in its new June update, compared with actual core PCE inflation of 2.5% y/y in April 2025. It also raised its previous forecasts for core PCE inflation from 2.2% to 2.4% in 2026 and from 2.0% to 2.1% in 2027.
Fed tweaks rate cuts Nevertheless, the Fed kept the potential for two quarter-point interest rate cuts on the table for later this year, perhaps starting at the September 17 FOMC meeting. But the Fed now expects only one rate cut (instead of two) in 2026, and it is still expecting only one cut in each of 2027 and 2028, at which point the fed funds rate would be at its terminal range of 3.00-3.25%. We here at Federated Hermes are still expecting two data-dependent, quarter-point cuts in the second half of this year.
Labor market slowing Initial weekly jobless claims (an important high-frequency leading indicator for labor-market health) rose to an eight-month high of 250,000 claims for the week ended June 6, although June’s survey week (which ended June 13) did ease to 245,000. Moreover, the smoother four-week moving average of 245,500 claims has surged to a nearly two-year high this past week (246,000 in August 2023). Finally, nonfarm payrolls have averaged nearly 124,000 new workers monthly so far this year through May, 31% lower than last year’s average of almost 180,000 workers monthly over the same five-month period. In addition, the Trump Administration’s current policy on immigration and deportation adds to this labor-market uncertainty.
Inflation declining, but… After stalling in the second half of last year, inflation has declined sharply so far this year. Core CPI retail inflation was mired in a tight 3.2-3.3% y/y range from June 2024 through January 2025. But core CPI has since plunged to a more than four-year low of 2.8% in May 2025. Core PCE inflation–the Fed’s preferred measure–was stuck in a range of 2.6-2.9% y/y over the past 11 months through February 2025 but has since plummeted to a more than four-year low of 2.5% in April 2025.
While Fed Chair Jerome Powell acknowledged during his press conference on Wednesday the significant decline in inflation so far this year, he added that the Fed was expecting “a meaningful increase in inflation in coming months,” related to potentially negative outcomes from fiscal policy and geopolitical developments. If the Fed was backward looking, he said, it would be cutting interest rates now, because monetary policy at present is modestly restrictive. But by being patient, he added, the Fed will “know a great deal more over the summer” months regarding trade policy, tariffs, tax legislation, immigration and the war in Iran and their collective impact on inflation.
Give peace a chance Crude oil prices (WTI) plunged by more than 30% from nearly $81 per barrel in mid-January to almost $55 in early May, which helped to drive inflation lower. But the recent instability in the Middle East has forced oil prices–at least temporarily–higher, surging by 40% to $77 per barrel over the past six weeks. Some bearish prognosticators are hyperventilating about crude prices possibly retracing to the $130 per barrel peak in March 2022, when Russia first invaded Ukraine.
However, we have a more sanguine view. Perhaps in anticipation of Israel’s pre-emptive strike on Iran’s nuclear facilities, Saudi Arabia and other OPEC nations have been flooding the global market with oil in recent months, while the US has boosted its Strategic Petroleum Reserve to a nearly three-year high of 402 million barrels. At the same time, President Trump has offered Iran a two-week diplomatic pause to reach a peaceful conclusion. In our view, it would be economic suicide for Iran to shut down the Strait of Hormuz, so we’re planning for a more constructive outcome.
Could the July 30 FOMC meeting be in play? Although it’s a decidedly out-of-consensus view, Federal Reserve Governor Chris Waller said this morning that he believes the central bank could begin to cut interest rates as early as the Fed’s next policy-setting meeting in six weeks.
On July 30, the Commerce Department will flash second-quarter GDP growth earlier that morning. We’ll also have another round of employment and inflation data in hand from earlier in the month, Trump’s July 9 tariff negotiating deadline will have come and gone, and the Iranian conflict may have mercifully ended.
When Trump left office the first time, nominal and core CPI were both at a very well- behaved 1.4% in January 2021, while core PCE was at 1.7%. So, tariffs did not have a meaningful impact on inflation then, and some Fed critics argue that central bankers may be overly pessimistic now.
The benefit to waiting until the Fed’s next meeting after that on September 17 is that it will have two months of additional labor-market and inflation data in hand, and participants will prepare an updated SEP outlook. In addition, at its annual monetary policy symposium at Jackson Hole, Wyo. on August 21-23, the Fed is expected to take a deep dive into the labor market. This year’s theme is “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy."