This was one of the more challenging Federal Reserve decisions to anticipate. US macro data has deteriorated so much that, normally, you’d expect policymakers to cut interest rates. However, they’ve already said tariffs are keeping them on hold for a while, unless things really fall apart. Military conflict between Iran and Israel can only make that hold longer.

Therefore, it was anyone’s guess what the Fed’s dot plot of interest rate projections would show. So I’m going to take a slightly different tack by mostly ignoring those forecasts and, instead, tell you what I’m seeing in the data, how I think the Fed will act and what that means for asset prices. 

The short version is that the US economy is decelerating so much that we should expect Fed rate cuts to resume in September. That’s largely bullish for Treasuries but bearish for the US dollar and equities. The only question is if that first cut will come too late to avoid a recession.

Here’s the train of thought that leads to that conclusion.

1. Consumption and labor market data are showing real weakness. If the trend continues, we could be in a recession by the end of the year.
2. July will be a pivotal month: The White House will have to make a decision on reciprocal tariffs. Plus, negative economic trends will either subside or be apparent to everyone by then.
3. Since economic sentiment has turned up, a firming of data plus a benign tariff outcome can take equities to new highs. But poor data or a bad tariff outcome should draw an outsized negative response from risk assets.
4. Because the one-time tariff price step-up hasn’t shown up in the data, the Fed won’t cut in July except in the most dire of circumstances. But, if data continue down as I anticipate or inflation stays low, the Fed would then cut in September.
5. If they cut in September because of poor data but not low inflation, it will probably be too late.

The Fed was a bit hawkish

The Fed dot plot was basically a push in terms of actual policy for 2025. We did see slightly higher rate expectations for year-end 2026 and year-end 2027.

What was more interesting was that those projections, highlighted in yellow, come against a backdrop of lower GDP and higher unemployment projections for this year and next. What the Fed is telling you is that inflation, now projected higher at the end of 2025, 2026 and 2027, is so elevated that they are willing to take a more hawkish stance even in the face of a deteriorating macro picture.

As for that deteriorating macro, four economic data releases over the past week — consumer and producer prices, retail sales and jobless claims tell the best story of where we are. Let’s start with the good news: inflation.

The two headline indices rose in the data released last week, but by less than anticipated. Consumer price inflation at 2.4% and producer prices up by 2.6% are both above the Fed’s 2% target. But that gives us some hope that inflation expectations remain anchored and that actual price increases from tariffs will be muted enough to push forward Fed rate cuts.

And based on the other two data prints, we’ll need those cuts. Retail sales, for instance, declined 0.9% month-on-month in May after declining 0.1% from March to April. The year-on-year number still looks robust at 3.3%. But we’re clearly seeing a vacuum of demand after people frontran tariffs by making purchases in the first quarter of the year. If that slump continues, it will eventually cause firms to reduce production and work down inventories. Capital investment should also fall. These are the business decisions — along with layoffs —  that can really tip economies into a recession.

As for layoffs, all of this is happening against the backdrop of ever-rising initial jobless claims. The four-week average of continuing claims is the highest since November 2021, essentially the highest post-pandemic level.

And average initial claims at 245,000 are at the highest levels since the 2023 recession scare and up 25,000 since the post-Liberation Day low in mid-April. With initial jobless claims averaging 32,000 more per week than in January, we’re edging closer to a lost wage shock that has been consistent with a recession in the past.   

The market is leaning the other way

If you combine that soft data with what the dot plot says about rate relief and Jerome Powell’s comments on Wednesday, it’s a dicey situation in terms of the economic support for corporate earnings. Given both the S&P 500 and Nasdaq 100 are near all-time highs, it’s clear US equity markets are expecting the data to improve.

Since the recession scare in April, stocks had already rallied more than 20% before the Fed’s rate hold in June. Therefore, a bounce on stronger data in the near term should be muted. Still, the S&P 500 has stalled around 6000 for the last month as if waiting for a new upward catalyst. If you were to combine economic firming with tariffs in the 10-20% range for the EU, Japan and China, that could galvanize a wave of capital investment, and you have the makings of new all-time highs.

Treasuries have been bid in part because of recent soft data. So, 4.50% for 10-year Treasuries and 5% for 30-year Treasuries that have acted as levels of resistance would be easy targets to hit in an upside economic scenario.

The downside here is that given the market has already rallied so much, and expectations for a recession have plummeted, continued data weakness and bad tariff outcomes should trigger a considerable sell-off in US equities.

We may not get the near-panic that took the S&P 500 below 5000 in April, but I would expect a correction in shares at a minimum. And all of that is very bullish for Treasuries, which should rally aggressively.

If we get the upside outcome that gets shares to new highs, it really won’t matter what the Fed does in July. They can continue to pause and shares will rally anyway. So what the Fed does after this week only matters if Trump brings back high tariffs.

Trump’s hectoring of Powell suggests that the president is looking for policy cover. Perhaps Trump has already decided that he’s a “tariff guy” who is going to enact steep levies and needs fiscal and monetary policy easing to offset those tariffs as soon as possible.

Therefore, you can picture a situation in July where the jobless claim data continue to worsen, pointing to the need for rate cuts from the Fed, but we also start the month with tariffs over 20% in some cases, more than double today’s baseline level. That would mean the Fed can’t cut for fear of inflation. 

That combination of rising inflation, slowing growth, and tighter policy  would create a strong reversal in sentiment, and probably push the Fed to cut in September. Obviously, events surrounding Israel and Iran are a big wildcard that could keep the Fed on hold even longer, as military action there presents mostly upside risks for inflation via higher oil prices.

In the downside scenario, since monetary policy acts with a lag, it would be too late to stop the US economy if it were on the way toward a recession. The best we could do is hope that lower interest rates ease the severity of a downturn and end it sooner. It would be ironic, though, if Trump’s unfailing belief in the power of tariffs tipped the economy into recession just when investors were least prepared for it to happen.

Things on my radar

• The growing relative price for protecting investors against a fall in Nasdaq-listed stocks tells you downside risk has increased.
• The US plans to make it easier for banks to hold lots of Treasury assets. At the margin, that’s good for their value.
• Elise Stefanik has asked the SEC to investigate a bond offering by Harvard. Targeting individual bond issuers like this has to hurt the attractiveness of the US as a place to do business.
• The increasing unattractiveness of the US is already a problem for the dollar.
• The stablecoin bill passed by the Senate tells you crypto has more room to run higher — as long as the economy holds.

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