The Fed and its dueling dual mandate

Analysis
Insights

Questions regarding the Federal Reserve’s price stability and maximum employment mandates abound. We look at what investors should know at a time when there is a lack of clarity regarding the central bank’s next moves.

Share

May 8, 2025

Thomas Garretson, CFA
Senior Portfolio Strategist
Fixed Income Strategies
Portfolio Advisory Group–U.S.

In no uncertain terms – which may be welcomed in a world of almost nothing but uncertainty – the Fed’s meeting this week was largely inconsequential.

But there were some minor developments that speak to larger themes that we think are worth exploring.

In newly added language to its official policy statement, the Federal Reserve Board noted that, “The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”

Fed Chair Jerome Powell went further in his prepared remarks to note that, “If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment.”

This theme, of course, is also increasingly being reflected in a wide swath of analyst forecasts. The first chart shows how far RBC Capital Markets’ economists expect inflation to deviate from the Fed’s 2.0 percent annual target, and how far unemployment is seen rising beyond the Fed’s 4.2 percent estimate of the “full employment” rate of unemployment.

Inflation and unemployment both seen exceeding Fed goals, but inflation to a greater degree

Inflation and unemployment expectations vs. Fed targets

The chart shows how much RBC Capital Markets expects inflation to deviate from the Fed’s 2.0 percent annual target and how much unemployment could exceed the Fed’s estimated 4.2 percent “full employment” rate. Inflation is expected to exceed the Fed target by up to 1.4 percentage points in Q4 2025, and unemployment by up to 0.6 percentage points.

  • Inflation gap
  • Jobless gap

Source – RBC Wealth Management, Bloomberg; RBC Capital Markets forecasts for the Consumer Price Index and unemployment rate as of April 2025

Breaking the tension

As Powell noted multiple times during his press conference, the prospects of both higher inflation and higher unemployment create “tension” with respect to achieving the Fed’s dual mandate of price stability and maximum employment, and how it manages its monetary policy tools in doing so.

So, the question then is which mandate will the Fed prioritise when it next decides to act?

Our current thinking is relatively straightforward: The inflationary impacts of tariffs will hit first, and to a greater degree, which has kept – and will likely keep – the Fed on hold until the September meeting. At which point rising unemployment, if realised, will trigger the first of a series of rate cuts – we think three this year followed by three next year – even in the face of elevated inflation. But inflation begins to fade, and unemployment stabilises, through 2026.

We would hope it goes without saying that even in the best of times forecasts are just that, forecasts. At the moment, any forecast likely isn’t much better than anyone’s worst guess. But this seems like a simple, and fair, framework to be working with.

Are inflation expectations dragging anchor?

Though the Fed noted that current economic growth remains solid and inflation only slightly elevated, the expectations component of both is the next theme which has been featured at recent meetings. Powell has routinely stated that the Fed’s job is to keep the one-time inflationary impact of tariffs from morphing into a persistent inflation problem.

As the second chart shows, that objective appears at risk. Consumer inflation expectations have been rising sharply since the beginning of the year. Though Powell downplayed this at the March meeting as “too soon to draw conclusion,” four months nearly makes a trend, in our view, with preliminary data for May due next week potentially extending it.

Decades of relative stability in inflation expectations upended

Expected change inh prices during next five to 10 years

Expected change in prices during next five to 10 years

The line chart shows long-run consumer inflation expectations over the past 25 years. Expectations were relatively stable around the 2.8 percent median for most of the period. In recent months, however, expectations for inflation have jumped to 4.4 percent, significantly higher than at any time in the past 25 years.

  • Consumer long-run inflation expectations
  • Median

Source – RBC Wealth Management, Bloomberg, University of Michigan Surveys of Consumers

This dynamic shouldn’t be ignored. In recent decades, the Fed largely achieved its goal of “anchoring” inflation expectations. By and large, expectations, even through the worst of the recent inflation wave, held within a tight range. This break, if sustained, could signal a material shift in consumer psyche as it relates to prices.

We wonder whether, if this round of tariff-induced inflation fears wasn’t coming off the back of an actual inflation wave which has only recently appeared to trough, it might prove to be a one-off episode. But coming so soon after an inflationary cycle could only fuel another where we could see the cycle of businesses raising prices, workers seeking wage gains to offset higher prices, and so on and so forth.

Rising inflation expectations also pose economic risks – if consumers fear higher prices ahead, they may spend now, and that could be what is currently holding up economic activity. But amid rising questions about the consumers’ capacity to spend and growing fears about their willingness, higher consumption now could mean lower consumption later.

Wait and see what may be

While the Fed meeting largely failed to move markets in any direction, the announcement of a framework trade deal with the UK today has done so. The S&P 500 has pushed higher toward 5,700, while the benchmark 10-year U.S. Treasury yield has risen to 4.33 percent.

We have maintained our Market Weight recommendation for both U.S. equities and U.S. fixed income, but recent volatility and market uncertainty present a precarious setup. As of April, RBC Capital Markets projected a year-end S&P 500 closing level of 5,550 – nearly 3.0 percent downside from current trading levels. At the same time, RBC Capital Markets forecasts the 10-year Treasury yield to end the year at 3.75 percent. Bond price appreciation should the yield decline to that level, on top of coupons earned, would imply a total return of just over 7.0 percent.

Should tariff and trade fears continue to ease, there is perhaps some modest upside to both of those forecasts. But in an environment such as this, perhaps it’s best just to follow the Fed’s lead and simply wait and see.

Let’s connect


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.


Thomas Garretson, CFA

Senior Portfolio Strategist
Fixed Income Strategies
Portfolio Advisory Group–U.S.

Related articles

Will investors see a pause in rate cuts, or the end?

Analysis 5 minute read
- Will investors see a pause in rate cuts, or the end?

Fed rate cuts for what?

Analysis 6 minute read
- Fed rate cuts for what?

The price of Fed rate cut success is steep, but not too steep

Analysis 12 minute read
- The price of Fed rate cut success is steep, but not too steep