Fed Holds Steady, But Market Sees Rate Cuts on the Horizon

The Federal Reserve's latest policy update has reinforced a dovish stance, shaping market expectations for the months ahead. The FOMC’s decision to hold rates steady was largely anticipated, but the downward revision in economic growth projections and an upward adjustment in inflation estimates have fuelled discussions about future policy moves.

The Fed’s Balancing Act Growth vs. Inflation

One of the most notable takeaways from the meeting was the Fed’s willingness to look beyond the inflationary impact of tariffs. While the median projection for core PCE inflation in Q4 2025 was revised higher to 2.8%, the GDP forecast saw a 0.4 percentage point reduction to 1.7%. This revision acknowledges the economic strain from the renewed tariff policies under the Trump administration, which the Fed assumes will trigger retaliatory measures from U.S. trade partners. However, Fed Chair Powell emphasized that the central bank’s inflation expectations for 2026 and 2027 remain stable, reinforcing their view that the current inflationary pressures will be transitory.

Despite a softer growth outlook, the unemployment rate projection for this year only saw a minor increase to 4.4%. This suggests that restrictive immigration policies could be offsetting labour market loosening, supporting wage growth even in a slowing economy. The Fed reiterated its cautious approach, emphasizing that while further rate cuts remain on the table, the pace will depend on incoming labour market data and broader economic conditions.

Market Reaction and Policy Implications

Following the FOMC statement, U.S. Treasury yields dropped, with the 2-year and 10-year yields falling by approximately 11bps and 8bps, respectively. This move has driven the USD/JPY lower, retreating from the 150.00 level to around 148.00. Market pricing now fully factors in a Fed rate cut by July, with a total of 66bps in rate reductions expected by year-end.

Additionally, the Fed announced a slowdown in its quantitative tightening (QT) program. The monthly cap on Treasury runoff will be reduced from $25 billion to $5 billion, while the MBS cap remains unchanged at $35 billion. This adjustment signals a preference for extending the QT process while maintaining flexibility in managing market liquidity.

GBP and the BoE’s Policy Trajectory

The British pound has benefited from improved investor sentiment towards European assets, with GBP/USD climbing above the 1.3000 mark for the first time since the 2024 U.S. election. However, against the euro, sterling has weakened slightly, with EUR/GBP moving back above 0.8400. The divergence between the ECB and BoE policy paths remains a key driver, with expectations of a slower rate-cutting cycle in the UK compared to the eurozone.

The Bank of England is set to update its policy stance, and while the market still expects a 19bps rate cut in May, confidence in an additional reduction by August has diminished. The resilience of wage growth, with private sector wages rising by 6.1% YoY in January, poses a challenge for the BoE’s inflation-fighting efforts. If inflation temporarily climbs back towards 4.0% during the summer, the central bank may adopt a more cautious easing trajectory.

The coming weeks will be crucial for gauging the Fed’s next steps. Market participants will closely watch the release of new trade policy details in early April, which could further shape inflation expectations. Additionally, employment data and inflation trends will remain pivotal in determining the timing and magnitude of rate adjustments.

For the dollar, the recent softness reflects a reassessment of Fed policy risks. However, the lack of aggressive selling suggests that much of the dovish repricing has already been factored in. As markets continue to digest economic data and central bank signals, volatility across major currency pairs is likely to remain elevated.

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