Fed review: Still in a good place

The Fed maintained its policy rates unchanged in the May meeting, as widely expected. QT continues unchanged also as expected.

Powell emphasized that the Fed is in a good place amid the high uncertainty and carefully avoided influencing financial conditions. We still maintain our Fed view unchanged and expect the next rate cut in June.

Market reaction was muted, with UST curve steepening slightly and EUR/USD declining close to the 1.13 level. Markets price in around 5-6bp worth of cuts for the June meeting and a total of 78bp by December.

While it's no news for anyone that uncertainty is high, and that the stagflationary risk outlook poses a challenge for central bankers, Powell affirmed that current policy stance is still well suited for the occasion. The Fed is prepared to act quickly if needed, but the current environment leaves no room for pre-emptive moves.

After the extreme market volatility seen in early April, the recent easing in financial conditions and the latest batch of solid hard data allow the Fed to remain in a wait-and-see mode, as we argued in our preview. Powell's very cautious tone and carefully balanced wording suggest that the policymakers do not intend to provide signals or influence financial conditions before gaining further clarity.

The policy statement received only two, largely cosmetic changes. The Fed acknowledged that despite the decline in net exports (due to front-loading), underlying growth remained solid in Q1. The statement also emphasized that risks of both higher unemployment and inflation have risen, but neither it nor Powell specified which risk is the more pressing concern at the moment.

Markets are pricing only 20-25% probability for a cut in the June meeting, which remains our base case. The rate cut hinges on two factors, clarity on tariffs and how they translate into hard data. On the former, Trump added to the uncertainty just before the rate decision by announcing that he is 'not open to pulling back on the 145% tariffs' even if US and China are set to begin preliminary trade talks over the weekend.

On the latter, we still think risks are skewed towards downside surprises as front-loaded demand fades and goods supply shortages become increasingly common - especially if reaching an agreement on reducing China-tariffs takes longer than expected.

We expect to see majority of the tariff-driven growth slowdown over the course of H2. So even if the Fed opts to remain on hold also in June, we remain confident in our call for three cuts in total for the rest of 2025. We maintain our call for the terminal rate at 3.00-3.25% reached by June 2026. Finally, the Fed made no changes to its QT as expected after the taper announcement in March. Powell did not comment on how the recent turmoil in UST markets might have influenced the committee's thinking on the final stages of QT.

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