The old saying, "Be careful what you wish for, because you might get it" likely applies to investors' and politicians' hopes for near-term rate cuts.
Rate cuts might give the market a quick sugar rush but wouldn't necessarily ease long-term borrowing costs that are keeping consumers and businesses somewhat gun-shy.
"Short-term interest rates are largely determined by Fed policy, but intermediate- to long-term rates are also influenced by inflation expectations and supply and demand for bonds," said Kathy Jones, chief fixed income strategist at Schwab. "If the Fed cuts rates too soon, it would likely raise inflation expectations, which could move intermediate- to long-term rates higher, especially in an environment where the supply of Treasuries is likely to keep rising due to increased spending in the Big Beautiful Bill."
That's a reference to the Republican budget bill under debate in Congress that the non-partisan Congressional Budget Office (CBO) has said would add around $3.3 trillion to U.S. budget deficits over the next decade. Higher deficits mean the government would likely have to issue more Treasuries to pay interest on the debt, possibly keeping Treasury yields elevated.
Though tariffs also contribute to a lackluster environment for parts of the economy, relatively high rates appear to be hurting housing and automobile demand. Recent declines in personal spending also raised concerns. Elevated rates can also slow capital expenditures for businesses reliant on borrowing, including the energy sector and small businesses in general.
President Trump, for one, has made it no secret he wants the Federal Reserve to lower interest rates, and two Fed policymakers recently said they're biased toward a July cut. The Fed last cut rates in December, and the target range hasn't moved since then, remaining between 4.25% and 4.5%. That's near the historic average but high compared with near-zero interest rates for much of the post-2008 period. Trump says current rates cost the country "hundreds of billions" in additional interest payments on U.S. debt and restrain the economy.
Lowering rates sooner might also help prevent an employment hiccup, Fed Governor Christopher Waller said in a recent CNBC interview.
"If you're starting to worry about the downside risk [to the] labor market, move now, don't wait," said Waller, appointed to the Fed by Trump in 2020. "Why do we want to wait until we actually see a crash before we start cutting rates? So, I'm all in favor of saying maybe we should start thinking about cutting the policy rate at the next meeting, because we don't want to wait till the job market tanks before we start cutting the policy rate."
Of course, Waller alone doesn't decide when rates go down. Fed Chairman Jerome Powell and other policymakers also have votes. Powell still sounds cautious about making rate cuts without knowing the ultimate impact of tariffs on inflation.
"The question is, who's going to pay for the tariffs?" Powell asked the Senate Banking Committee last Wednesday, according to Bloomberg. "How much of it does show up in inflation? And honestly, it's very hard to predict that in advance."
Powell believes tariff-driven inflation remains possible and added that the Fed is in a good position to wait. The last "dot-plot" of rate projections in June suggested Powell has lots of company, as seven policymakers are predicting no rate cuts this year, up from four who thought the same in March.
That said, Powell showed flexibility under questioning from House members last week, saying if tariff-driven inflation doesn't show up in the June and July data, he might be open to the idea that perhaps the impact will be less than expected.
"If it turns out that inflation pressures do remain contained, then we will get to a place where we cut rates sooner rather than later," Powell said in response to a question about chances for a July rate cut, Bloomberg reported. "But I wouldn't want to point to a particular meeting. I don't think we need to be in any rush because the economy is still strong."
Economic strength is one reason a rate cut might not have the impact politicians and market participants hope for. Though parts of the economy struggle, the latest Atlanta Fed GDPNow gross domestic product (GDP) growth estimate for the second quarter is 2.9%. While this reading is down from 3.4% on June 18, it's still not near recession territory.
In addition, the jobs market has been resilient, though initial jobless claims have risen over the last month. Unemployment remained historically low at 4.2% in May. That could change, but the Fed would likely need to see several months of soft labor numbers to convince many policymakers that there is a dip in labor demand serious enough to require rate cuts.
All this means is if the Fed cuts rates now, it risks not seeing that backed up by the markets. The market itself determines the rates that go into long-term interest costs for big items like cars, homes, new manufacturing plants, hiring, or mergers. A rate cut when there's no outstanding economic case for one could force inflation higher. What's more, the mere fear of that scenario might keep longer-term Treasury yields elevated if the Fed cuts at a point the market believes is too soon. Higher inflation and climbing long-term yields aren't a good recipe for stocks, which recently traded at or near record highs for major U.S. indexes.
"We need to be mindful that under pressure to cut too soon, we could have an experience like last fall when the Fed cut by 100 basis points…over that same period of time, we had a 100 basis-point increase in the 10-year yield," said Liz Ann Sonders, chief investment strategist at Schwab, speaking on CNBC late last week.
"The 10-year market was saying, 'wait a minute, you may be loosening too quickly or by too much'…part of the reason the market is doing well is that the Fed is reinforcing why they put themselves in a time-out, and that's probably the right decision for now. I think [because] Powell is being pragmatic and sticking to his guns on the Fed's dual mandate, the market is keying off that in a positive way."
The benchmark 10-year Treasury note yield traded between 4.3% to 4.5% for most of the last two months but recently fell below 4.3%. Spikes in January and again in April and May appeared to spook stocks, though effects were short-lived because the yield quickly fell each time. It's unclear how stocks might react if yields moved higher for longer, but there is precedent: The S&P 500® index (SPX) had a tough time in late 2023, falling roughly 10% from a July peak to an October trough. That coincided with the 10-year yield rising from 3.7% to 4.8%.
Market history doesn't necessarily repeat itself, so there's no guarantee that the Fed cutting rates at its meeting in late July would cause yields to rise or inflation to pop. It's just theoretical, but it's one thing the Fed needs to consider. Tariffs make the challenge tougher.
"Middle East news took tariffs off the proverbial front pages, but focus may shift back in that direction," Sonders said, noting the lack of meaningful trade deals being reached and the July 9 deadline for Trump's "reciprocal" tariffs to take effect.
Of course, by the time the Fed meets, policymakers may have a better sense of the tariff picture and certainly more insight on how the labor market and inflation are responding to tariffs and other pieces of the economic puzzle. Investors and President Trump may get what they want then, but for now, it appears they'll have to stay patient.
Early this week, the market built in around a 19% chance of a 25-basis-point cut at the July 30 Federal Open Market Committee (FOMC) meeting, according to the CME FedWatch Tool Chances improve at the September meeting, with investors penciling in more than 90% odds of at least one cut by then.
And the Fed's dot-plot still plugs in two rate cuts this year, which would take the target range below 4% by December. Would the 10-year note yield join it down there, giving stocks more traction? Last year's precedent suggests it's more complicated than that.
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