Inflation remains calm in 2025, but tariff-related price hike concerns have kept the Fed sidelined. We look at the Fed’s commentary, the impact of market forces and political pressure on yields, and the probability of rate cuts before year’s end.
June 20, 2025
Thomas Garretson, CFA Senior Portfolio StrategistFixed Income StrategiesPortfolio Advisory Group–U.S.
As was widely expected among the analyst community, the U.S. Federal Reserve held rates steady for the fourth consecutive meeting this year. But it was at the first of those meetings back in January where Fed Chair Jerome Powell, when asked about the potential impact of tariffs on inflation under the incoming administration, uttered what has become his mantra, “You know, there are lots of places where that price increase from the tariff can show up between the manufacturer and a consumer. Just so many variables. So we’re just going to have to wait and see.”
So, after months of waiting, inflation data have only proved to be remarkably tame. Consumer Price Index (CPI) data through May showed headline inflation had been running at an annualised rate of only 1.0 percent over the prior three months, and core inflation (excluding volatile food & energy components) was also running nowhere fast at just 1.7 percent, both shy of the Fed’s 2.0 percent target.
But the Fed, like markets, is only concerned about what the future might hold. Skate to where the puck is going, not to where it’s been, as they say. The Fed’s updated inflation forecasts showed Personal Consumption Expenditures (PCE, its preferred measure of inflation) rising to 3.0 percent by the end of the year, up from a forecast of 2.7 percent in March.
As Powell pointed out in his press conference, it’s not just the Fed that expects the tariff-related impact on inflation finally to materialise later this summer; it’s also most economists, certain market-based measures, consumer surveys, and numerous surveys of businesses.
Indeed, those metrics have indicated that plenty of inflationary risks remain. One such survey from the Institute for Supply Management (ISM) of service-sector businesses showed that when asked whether prices are higher relative to the month before, 45 percent of those surveyed by the ISM reported that to be the case, the most since January 2023.
The chart shows the relationship between the ISM Services PMI survey on prices and the Consumer Price Index. 45 percent of companies surveyed reported higher prices in May which suggests that consumer prices could rise in the months ahead.
ISM survey for May 2025 advanced three months; PCE inflation data through April 2025; horizontal axis crosses at Fed’s 2 percent inflation target
Source – RBC Wealth Management, Institute for Supply Management (ISM), Bloomberg
That index has tended to lead realised inflation by about three months with a high correlation. And while year-over-year CPI inflation was just 2.4 percent in May, RBC Economics expects that to rise to 2.9 percent in the back half of the year. Other market-based measures from the CPI swaps market suggest the annual rate of inflation could rise higher still to north of 3.0 percent by year end.
Although it may be perfectly fair to ask why the Fed isn’t cutting rates at the current juncture, the Fed’s updated rate projections showed that the median member still expects two rate cuts this year. Of the 19 policymakers on the Federal Open Market Committee, which sets monetary policy, eight projected two 25-basis-point rate cuts by December; at the other end, there’s a growing cohort that sees no rate cuts this year, a group which grew to seven this week from just four back in March.
U.S. President Trump again this week had sharp criticism of Powell and expressed his desire to see 200 basis points of rate cuts immediately, having previously wanted 100 basis points of reductions. He stated that the Fed’s inaction is costing the U.S. “hundreds of billions” of dollars in financing costs.
To be sure, and in no uncertain terms, there is not a political component to any of the Fed’s calculus, in our view.
Yes, the Fed is certainly a powerful institution, but it doesn’t act in isolation and, like so many other things, is not impervious to economic or market forces.
Market forces have also defied the Fed’s actions thus far. Despite already cutting its overnight policy rate by 100 basis points to 4.5 percent from 5.5 percent late last year, the key 10-year borrowing rate for the U.S. (upon which many consumer rates are based) has risen by nearly 75 basis points to around 4.4 percent. Relatedly, the average 30-year fixed mortgage rate has increased by 26 basis points to 6.8 percent.
The chart shows the changes in key interest rates and Treasury yields since the Federal Reserve started cutting short-term policy rates in September 2024. While the federal funds rate has been cut by 100 basis points, the 10-year Treasury bond yield has risen by 74 basis points and the average 30-year mortgage rate has risen by 26 basis points.
Put simply, the market is saying via these higher long-term Treasury yields that tariffs raise risks of inflation and that potentially higher deficits, should unfunded tax cuts come to pass, would likely add to those pressures, while also adding to the debt burden – and arguably boosting the growth outlook. All of these things actually limit the Fed’s ability to cut rates.
If the Fed were to cut its short-term policy rates now – at a time of relative economic strength and stability amid a still-solid labour market backdrop – we feel confident that market forces would only propel more of what we have already seen: higher Treasury yields and, consequently, higher government, consumer, and business borrowing rates.
At the end of the day, however, we would again simply remind investors and clients that, in our view, high interest rates should generally be seen as a positive thing. They are a sign of economic strength and stability. Nonetheless, some in the U.S. would likely love nothing more than a return to the era of free money and low interest rates that prevailed during a time of sluggish growth, elevated unemployment and underemployment, and underinvestment.
As long as the administration’s policies are largely at odds with lower interest rates – for both positive and perhaps not-so-positive reasons – the Fed, though powerful, may be powerless to do anything about it.
We want to talk about your financial future.
This publication has been issued by RBC’s Wealth Management international division in the United Kingdom and the Channel Islands which is comprised of an international network of RBC® companies located in these jurisdictions and includes RBC Europe Limited and Royal Bank of Canada (Channel Islands) Limited. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by RBC’s Wealth Management international division.
This publication has been compiled from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgements as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, the value of investments and income arising can go down, future returns are not guaranteed, and an investor may not get back the amount originally invested. Countries throughout the world have their own laws regulating the types of securities and other investment products and services which may be offered to their residents, as well as the process for doing so. As a result, any securities or services discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law none of the entities which comprise the international division of RBC Wealth Management nor any of their affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Wealth Management.
Clients of RBC Europe Limited may be entitled to compensation from the UK Financial Services Compensation Scheme (FSCS) if it cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. For further information about the compensation provided by the FSCS scheme (including the amounts covered and eligibility to claim) please refer to the FSCS website FSCS.org.uk. Please note only compensation related queries should be directed to the FSCS. Royal Bank of Canada (Channel Islands) Limited is not covered by the UK Financial Services Compensation Scheme.
RBC Europe Limited is registered in England and Wales with company number 995939. Its registered office is 100 Bishopsgate, London EC2N 4AA. RBC Europe Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Royal Bank of Canada (Channel Islands) Limited (“the Bank”) is regulated by the Jersey Financial Services Commission in the conduct of deposit taking, fund services and investment business in Jersey. The Bank’s general terms and conditions are updated from time to time and can be found at https://www.rbcwealthmanagement.com/en-eu/terms-and-conditions. Registered office: Gaspé House, 66-72 Esplanade, St. Helier, Jersey JE2 3QT, Channel Islands. Deposits made with Royal Bank of Canada (Channel Islands) Limited in Jersey are not covered by the UK Financial Services Compensation Scheme. Royal Bank of Canada (Channel Islands) Limited is a participant in the Jersey Bank Depositors Compensation Scheme. The Scheme offers protection for ‘eligible deposits’ up to £50,000 per individual claimant, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any 5 year period. Full details of the Scheme and banking groups covered are available on the Government of Jersey’s website http://www.gov.je/dcs or on request.
Investment services offered by the Bank are not covered by an investor compensation scheme as there is currently no such scheme operating in Jersey, however ‘eligible deposits’ held pursuant to investment services may be protected under the Bank Depositors Compensation Scheme described above – for more information see the Bank’s general terms and conditions. Some of the products that the Bank might recommend to you could be registered overseas and may be covered by a local compensation scheme. Your investment counsellor will provide you with the details of any overseas compensation schemes (where applicable) at the time of making an investment recommendation.
Copies of the latest audited accounts are available upon request from the registered office. ® / ™ Trademark(s) of Royal Bank of Canada. Used under licence.