Fed and the ECB: rates on hold but still issues to resolve

Federal Reserve

The Fed held rates steady at 4.25% to 4.50% last night, sticking to its cautious stance despite mounting pressure to ease. Labour markets remain robust and inflation stubbornly above target, but the real story was the dissent - Governors Christopher Waller and Michelle Bowman broke ranks, calling for a cut. That’s the first time since 1993 two Fed governors have opposed the Chair. Their push for easing reflects growing concern that the economy is softening faster than expected, and that the Fed risks overtightening if it waits too long.

Chair Jerome Powell wasn’t swayed. He made it clear: the Fed needs more data before making any moves. No promises, no hints - just patience. Powell downplayed the June dot plot that suggested two cuts this year, instead stressing that the full impact of tariffs on inflation is still unclear. The message? September is not off the table, but don’t bet on it just yet. He reiterated that the Fed is “data dependent,” and that any shift in policy will be driven by clear signs of cooling inflation and weakening labour markets.

Markets didn’t love the ambiguity. Equities dipped, Treasury yields ticked up, and rate cut bets for September now sit at a coin toss. The market has scaled back its expectations for 2025 easing to just under two cuts.

The Fed’s announcement came as the White House rolled out fresh tariffs, along with tweaks to shipping exemptions. These could push up prices in targeted sectors, adding noise to inflation readings. Powell acknowledged the uncertainty, noting that some effects may be short-lived, but others could linger. The Fed is watching closely, but not reacting prematurely. The challenge now is separating temporary price spikes from genuine inflationary pressure—something Powell admitted will take time to assess.

Markets didn’t love the ambiguity. Equities dipped, Treasury yields ticked up, and rate cut bets for September now sit at a coin toss. The market has scaled back its expectations for 2025 easing to just under two cuts. The dollar firmed slightly, and the yield curve flattened—classic signs of a market recalibrating to a more hawkish Fed. Investors were hoping for a clearer signal, but Powell’s cautious tone left them guessing, and risk assets responded accordingly.

Still, a September cut isn’t off the table. If jobs data softens and inflation cools, the Fed could pivot in the final quarter. We still expect weaker labour prints are the most likely path to a cut. For now, it’s a waiting game, and the next few data releases will be critical in shaping the Fed’s next move.

European Central Bank

Having cut interest rates by a cumulative 2% over its previous eight meetings, the ECB had already set expectations as to the likely outcome of its July meeting, having stressed that they were in a “good place” at their last meeting, some seven weeks ago. In the intervening period, economic and financial data had broadly come in as expected, uncertainty arising from tariff tensions with the US appear have had abated somewhat, with a trade deal on the horizon and, in a meeting where no new ECB staff forecasts were due, it came as no surprise that the Governing Council elected to keep rates on hold. The mantra of data dependency, no pre-set commitment to a particular rate path and a “meeting by meeting” approach to decision making still held.

The market, however, interpreted this as something of a hawkish shift, which saw European Government Bond yields rise in the aftermath and rate cut expectations fall. Prior to the meeting, one full further rate cut was 100% priced for this year, however post the meeting, this had fallen to around 70%.

The press conference that followed the release of the statement on monetary policy decisions was a somewhat anodyne affair, compared to recent ones, with ECB President Christine Lagarde painting a picture of a central bank which was content with the impact of its actions over the past several meetings and data responding as anticipated. The continued elevated levels of uncertainty, and the role that this plays in their decision making process, was highlighted, but the overall tone was perhaps more balanced than we have seen of late.

Indeed, mention was also given to the possibility of the next move in interest rates being a hike (something that had been rebuffed in prior meetings), though this was in the context of explaining – once again – about being data dependant and not pre-committed to a particular rate path. The market, however, interpreted this as something of a hawkish shift, which saw European Government Bond yields rise in the aftermath and rate cut expectations fall. Prior to the meeting, one full further rate cut was 100% priced for this year, however post the meeting, this had fallen to around 70%.

What is clear now is that, absent a significant exogenous shock, we are close to (if not at) the end of this rate cutting cycle in Europe. The bar to hiking rates does seem reasonably high, so a period of interest rates remaining around this level seems to be the most likely scenario in the short to medium term. The impact of increased trade tariffs on inflation, business confidence and investment and, therefore, economic growth, remains to be seen.

A period of fiscal expansion by European Member States is also on the cards, so whilst it may no longer be monetary policy decisions driving European Government Bond markets, we are unlikely to see market volatility abating any time soon.

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