Traders focus on chance of just one 2025 Fed rate cut — or zero — due to tariffs, Mideast

Heightened uncertainty surrounding tariffs, oil prices, and the Israel-Iran conflict is leading market participants to believe the Federal Reserve may deliver fewer interest rate cuts than previously anticipated, with some now focusing on the possibility of only one cut or even none in 2025. The market is closely watching the Fed's upcoming policy announcement, particularly the 2025 "dot," to gauge policymakers' conviction amid tariff uncertainty, as a hawkish outlook could strengthen the dollar. While the overall trajectory for rates is expected to be lower, the pace of decline remains uncertain, making short-term rate increases a potential buying opportunity.

Analysis

Heightened uncertainty surrounds the Federal Reserve's 2025 interest rate trajectory, with market participants increasingly considering the possibility of fewer than the previously anticipated two quarter-point cuts, potentially just one or even none. This shift in outlook is driven by several factors: President Trump’s April 2 announcement of a 10% baseline tariff on most imports set to be reviewed in July, the unresolved U.S.-China trade war, and geopolitical tensions from the Israel-Iran conflict, which introduce volatility to oil prices and could trigger a new inflation wave. Fed-funds futures traders currently assign a 35.6% probability to the Fed delivering less than two cuts in 2025, indicating a potential market disappointment if the Fed validates these concerns.

The upcoming Fed policy announcement, particularly the 2025 "dot plot," is a critical focus, as it will signal policymakers' conviction levels amidst these uncertainties. Matthew Ryan of Ebury suggests that while two 2025 Fed rate cuts might remain the base case for most policymakers, a hawkish shift by even a few officials could tilt the median forecast to just one 25bp cut in 2025, an outcome that could strengthen the U.S. dollar. The Fed's March inflation projections for 2025 stood at 2.7% (PCE) and 2.8% (core PCE), with the fed-funds rate target unchanged at 4.25%-4.5% since December of the prior year. Greg Faranello from AmeriVet Securities notes that a forecast of only one 2025 rate cut would likely be viewed as "more hawkish," potentially causing a rise in short-term rates like the 2-year Treasury yield, which could present a buying opportunity. He also highlights the possibility of no rate cuts in 2025 and suggests traders might discount 2026-2027 projections due to prevailing inflation uncertainty and the fact that Chair Powell's term expires next year, potentially leading to a replacement under a Trump administration. Despite the near-term ambiguity, the broader expectation remains for an eventual decline in rates, though the pace is highly uncertain.

Key Decisions for Investors

• Investors should prepare for potential market repricing if the Federal Reserve signals fewer than two rate cuts for 2025, a scenario with a 35.6% probability currently implied by fed-funds futures.
• Closely monitor the upcoming Federal Reserve policy statement, the revised 'dot plot' for 2025, and Chair Powell's commentary for shifts in the inflation outlook and the central bank's assessment of risks from tariffs and geopolitical events.
• A more hawkish Fed stance reducing the number of projected 2025 rate cuts could lead to U.S. dollar appreciation and an increase in short-term Treasury yields, potentially offering tactical entry points for fixed-income investors anticipating an eventual, albeit delayed, easing cycle.
• Given the acute uncertainty regarding trade policy, energy prices, and geopolitical developments, maintain a cautious approach towards interest rate-sensitive assets and evaluate portfolio resilience to persistent inflation and increased market volatility.