Overall, despite political uncertainty, inflation exceeding the target level, and a possible one-time price increase due to tariffs, the Federal Reserve is expected to continue cutting interest rates in 2025 and throughout 2026. This comes amid a minimum consensus within the Federal Reserve Board on the need to resume rate cuts, a weakening economy, and the emergence of a broad majority of “monetary easing supporters” within the Board of Governors and the Federal Open Market Committee in the coming months.

It is rare for the US Federal Reserve not to lead the economic policy agenda, drive related discussions, and set their items. However, in recent months, worsening political uncertainty caused by the Trump administration has shifted full attention to executive actions, pushing the Federal Reserve to follow and adapt to macroeconomic discussions rather than lead them.

This non-proactive approach by the Federal Reserve was also clearly observed for the first time at the prestigious Jackson Hole symposium earlier this month, where leading economists, bankers, market participants, academics, and policymakers met to discuss the over-politicization of economic programs and plans, according to the QNB economic team.

The unprecedented levels of unpredictability in financial and trade developments, which pushed the US economic policy uncertainty index to its highest ever, make estimating or forecasting growth and inflation extremely difficult.

Despite moderation since the spikes following the announcement of tariffs on “Liberation Day,” political uncertainty remains high, generally above levels recorded during other acute stress episodes such as the global financial crisis (2007-2009), the European debt crisis (2009-2011), and the COVID-19 pandemic (2020).

The report added that working in such an environment is not an easy task for the Federal Reserve. As a reference point, medium-term interest rate expectations have fluctuated significantly, reflecting a temporary market consensus about the timing and even direction of federal funds rates over the next few quarters. Federal funds futures yields, which declined between Q2 and Q3 2024 due to the rapid drop in inflation rates and the anticipated significant monetary easing, rose in the last quarter of last year when Trump led the US elections with a pro-growth agenda. Since February 2025, with investor and consumer sentiment negatively affected by strict trade measures, yields have fallen sharply before stabilizing in recent months.

Investors currently expect the Federal Reserve to resume the rate-cutting cycle that began in September 2024, with “expectations” of two additional 25 basis point cuts in the federal funds rate by the end of 2025 and further cuts throughout 2026, stabilizing the terminal rate at around 3% by late next year through 2027.

From the QNB economic team’s perspective, prevailing market expectations align with macroeconomic conditions, indicating ample room for the Federal Reserve to make further rate cuts. Three main factors support this view.

First, despite the significant division in recent Federal Open Market Committee meetings, Federal Reserve officials continue to express their expectations to resume rate cuts in the coming months. The June 2025 “dot plot,” showing the expected target range for official interest rates from each of the nineteen committee participants, does not differ from the prevailing market view over the next few quarters. This supports most Federal Reserve officials’ opinion that, regardless of inflation remaining above target, the economy is gradually slowing, with inflation expected to return to normal over the medium term, and any potential tariff impact on inflation likely temporary and to be “ignored.”

To clarify, short-term inflation risks are expected to rise, but this does not justify the current abnormally high real interest rates. With inflation at 2.7% and the federal funds rate at 4.5%, real interest rates are very restrictive at 1.8%, which is 264 basis points above the long-term average. This situation allows significant room for additional rate cuts in the near future.

Second, the combination of cyclical economic slowdown and negative political shocks affecting sentiment indicates that further rate cuts are not only appropriate but necessary. The US economy has undergone significant adjustment in recent quarters, helping ease the supply-demand imbalance that pressured prices. This is clearly reflected in the rapid weakening of labor markets. After reaching maximum tightness in early 2023, with unemployment well below the balance level at 3.4%, labor markets have fully adjusted and are now deteriorating further to concerning levels. The unemployment rate reached 4.2% in July 2025, approaching the balance rate estimated by the Congressional Budget Office. Other labor measures, such as new job openings, have been weak. This suggests further labor market deterioration ahead, leading to employment challenges in the US.

While there remains division within the Federal Open Market Committee on whether the main issue at this stage is unemployment or inflation, natural economic dynamics point to increased future focus on employment. This was hinted at by Federal Reserve Chair Powell in his Jackson Hole speech when he mentioned a “shift in the risk balance” as justification for resuming rate cuts. Furthermore, the US capacity utilization rate, measuring unused productive capacity, also indicates the US economy has been operating well below its potential or long-term trend for over a year. These conditions support additional rate cuts toward at least neutral levels in the coming quarters, i.e., core interest rates near the neutral rate of 3%.

Third, political conditions and ongoing changes in the Federal Reserve Board composition are likely to strengthen the “monetary easing supporters'” dominance in Federal Open Market Committee decisions. President Trump was explicit in his preference for significant official rate cuts and appointing a new Federal Reserve Chair more aligned with his views. Chair Powell’s term ends in May 2026, allowing Trump to increase his influence over the Federal Reserve, as potential candidates will have to demonstrate or increase their “monetary easing” stance and support for rate cuts. The recent resignation of Adriana Kugler, one of the most “hawkish” FOMC members, earlier this month is also expected to further tilt the balance of power toward “monetary easing supporters” who want faster and deeper rate cuts.

Overall, despite political uncertainty, inflation exceeding the target, and a possible one-time price increase due to tariffs, the Federal Reserve is expected to continue cutting interest rates in 2025 and throughout 2026. This is based on a minimum consensus within the Federal Reserve Board on the need to resume rate cuts, a weakening economy, and the emergence of a broad majority of “monetary easing supporters” within the Board of Governors and the Federal Open Market Committee in the coming months.