Fed likely to resume slashing interest rates in December, Deutsche Bank predicts

Deutsche Bank analysts project the Federal Reserve will initiate interest rate cuts in December, followed by two further quarter-point reductions in Q1 2026, targeting a 3.625% neutral rate. This contrasts with market expectations for a September cut and the Fed's current 'wait-and-see' stance, largely driven by the potential inflationary impact of President Trump's tariff agenda, with a pause expiring August 1. While the FOMC is anticipated to hold rates steady next week, internal dissent persists, as Governor Waller advocates for a July cut despite broader concerns over accelerating inflation.

Analysis

A significant divergence exists between analyst, market, and Federal Reserve expectations for the monetary policy trajectory, primarily driven by uncertainty surrounding U.S. tariff policy. Deutsche Bank projects a delayed easing cycle, with an initial rate cut not occurring until December, followed by two more reductions in Q1 2026 to reach a neutral rate of 3.625%. This contrasts with current market pricing, which, according to the CME FedWatch Tool, indicates a potential cut in September, albeit with low conviction at just over 50% probability. The Federal Open Market Committee is maintaining a "wait-and-see" approach and is widely expected to hold its policy rate at 4.25% to 4.5% in its upcoming meeting. This caution is fueled by the potential inflationary impact of President Trump's tariffs, with a pause on these duties set to expire on August 1. Fed Chair Jerome Powell's expectation of accelerating summer inflation, supported by data showing rising prices for some tariff-exposed goods, reinforces this hawkish stance. However, the Fed's consensus is not uniform, as evidenced by Governor Christopher Waller's advocacy for a more dovish July rate cut, signaling that the policy outlook remains highly data-dependent and sensitive to political developments.

Key Decisions for Investors

• Investors should closely monitor the August 1 tariff deadline, as the implementation of heightened duties would likely increase inflationary pressures and push the timeline for Fed rate cuts further out, creating headwinds for risk assets.
• Given the discrepancy between market pricing for a September cut and Deutsche Bank's forecast for a December cut, consider positioning for increased volatility in interest rate futures and re-evaluating duration risk in fixed-income portfolios.
• Pay close attention to upcoming speeches from FOMC members, particularly the dissenting commentary from officials like Governor Waller, as any shift in the balance of opinion could signal a change in the Fed's reaction function to inflation and labor market data.