US monetary policy appears to be entering a new phase. After holding the federal funds rate steady throughout the first half of 2025, the Federal Reserve (the Fed) now faces mounting market expectations for a shift toward easing. At the time of writing, investors were betting the Federal Open Market Committee (FOMC) will cut rates at each of its three remaining meetings this year. Even economists are increasingly on the same page, with FocusEconomics panellists forecasting a total of 50 basis points in reductions by year-end.
The case for at least a September rate cut is compelling. While GDP rose at an annualised 3% in Q2, this was flattered by a sharp drop in imports, masking weaker underlying momentum. ‘Core GDP’ growth slowed from 1.9% in Q1 to 1.2% in Q2, amounting to just 1% in H1 2025 versus 1.5% a year earlier. Consumer spending — the post-pandemic growth engine — also cooled to an average 1% across Q1 and Q2 2025, from a 3% average in 2023 and 2024, while the latest bleak jobs report showed weak payroll gains in July and downward revisions to prior months. The signal is clear: the US economy is cooling.
Beyond September, however, the outlook is less certain, with tariff effects yet to materialise and the ongoing truce with China offering only temporary relief.
Moreover, we are seeing an emergence of a ‘dual speed’ US economy. Lower-income households are under strain amidst slowing wage growth, elevated credit-card delinquencies and a weaker labour market.[1],[2] In sharp contrast, higher-income households and corporates remain buoyant, with strong wage growth at the top end and a weaker dollar helping 79% of companies beat Q2 earnings expectations.[3] A key driver of this divergence is current financial conditions, with the Fed’s own index stating that, far from restraining the economy, current financial conditions have acted as a tailwind to GDP growth throughout 2025.[4] Equity markets are riding the AI boom, and in some corners, easy access to capital is fuelling asset price inflation. The result is an economy cooling in parts but overheating in others, complicating the Fed’s path forward.
Yet, these are not the only forces at play. Taking a longer view, the shadow of fiscal dominance is stretching over US monetary policy. Soaring public debt and rising interest costs, which hit US$1.1 trillion in fiscal year 2024, could add pressure on the Fed’s decisions toward keeping financing costs down, even if inflation is not fully under control.[5] President Trump has openly called for immediate rate cuts to ease the debt-servicing burden, underscoring the political pressure at work.
The Treasury’s bond buy-back programme, launched on a scale and timeline not seen in recent years, has further fuelled debate. The programme is no yield curve control (YCC) normally undertaken by central banks to pin yields at a certain level: it sets no explicit yield targets and is aimed at supporting liquidity and improving cash management. More importantly, compared to the scale of US debt, its impact is insignificant. That said, its optics have sparked debate over the distinction between fiscal and monetary policy.
The challenge is not uniquely American either: advanced economies worldwide are grappling with the same debt dynamics. The Bank of England, for example, cut rates only recently despite stubborn domestic price pressures. The move was and can be justified by signs of a cooling labour market but also lightens the Chancellor’s load as she confronts yet another black hole in the public finances ahead of the Autumn Budget. With interest payments on government debt among the fastest-growing lines in the UK budget since the pandemic, the incentive to lower borrowing costs is plain.
The European Central Bank’s (ECB) path offers a nuanced parallel: its rate-cutting cycle in the first half of 2025 unfolded against a backdrop of France’s widening budget deficit and Germany’s substantial fiscal easing to jolt a stagnating economy. In the ECB’s case, the rationale is arguably more clear-cut: inflation has eased sharply, and growth remains subdued, giving policymakers room to loosen. Even so, lower borrowing costs do help inevitably free up scarce funds and/or ease the interest burden for politically urgent priorities within individual member states. Those priorities are multiplying, too, from shoring up public services amidst an ageing population to meeting rising defence-spending commitments across NATO. Evidently, the line between supporting growth and managing government balance sheets is becoming harder to draw.
The Fed’s next moves specifically carry outsized importance, not simply because it will set the tone for monetary policy for the world’s largest economy, but because of the unique mix of forces bearing down on it. The risk is not just one of credibility or messaging – the Fed will undoubtedly be keen to not add another footnote to its missteps of 2021 – but whether its decisions accelerate broader rethink of the role central banks are expected to play.
In an environment where high public debt, political pressures, and global commitments are pushing central banks toward a more active role in managing government balance sheets, the old model of strict independence looks increasingly strained. The coming years may see mandates evolve, explicitly or implicitly, to reflect this reality. If so, the Fed’s handling of its current tightrope may well mark the opening chapter of a new era in global central banking.
Cebr’s next Forecasting Eye will be released on 19th September.
Contact:
Pushpin Singh, Managing Economist, psingh@cebr.com, 020 7324 2871
[1] Federal Reserve Bank of Atlanta