Fed Pauses Rate Cuts: Higher for Longer Returns

Khan Capital | March 2025

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Key Takeaways

• The Fed held rates at 4.25-4.50% for the second consecutive meeting, revising core inflation upward to 2.8% and unemployment to 4.4%, reflecting the stagflationary impulse from the tariff regime.
• The dot plot maintained two projected cuts for 2025 but the distribution widened, with more members favouring no cuts and fewer favouring more than two, signalling elevated uncertainty within the Committee.
• The Fed announced a near-cessation of Treasury QT (reducing the monthly cap from $25 billion to $5 billion), a significant but under-reported easing of financial conditions.
• Tariffs present a unique challenge: they function as a supply-side shock that raises prices without generating growth, leaving the Fed unable to address inflation through rate hikes or support growth through rate cuts.
• The pause is a holding pattern rather than a policy equilibrium: the next move will be determined by whether the labour market deterioration accelerates (forcing cuts) or inflation remains sticky (forcing an extended hold).

The Federal Reserve voted unanimously on 19 March to hold the federal funds rate steady at 4.25-4.50%, its second consecutive meeting without a rate change following three cuts in the final quarter of 2024. The decision was widely expected. What was not expected was the accompanying Summary of Economic Projections, which revised core inflation forecasts upward to 2.8% (from 2.5%) and raised the unemployment rate estimate to 4.4% (from 4.3%), while trimming growth projections. The message was unmistakable: the tariff regime is introducing a stagflationary impulse into the economy, and the Fed has no intention of cutting rates until the picture clarifies.

“Higher for longer” is back. The phrase that defined 2023’s monetary policy debate has returned, albeit in a different form. In 2023, the Fed held rates high because inflation was running far above target and needed to be brought down through demand destruction. In 2025, the Fed is holding rates high because it cannot determine whether the inflationary pressure it sees is demand-driven (which rate hikes can address) or supply-driven (which they cannot), and cutting into supply-side inflation risks embedding price pressures without generating the economic benefits that easier policy would normally deliver.

The Tariff Complication

The elephant in the room is the tariff regime. Since inauguration, the Trump administration has imposed 25% tariffs on imports from Mexico and Canada, raised tariffs on China to a cumulative rate that far exceeds pre-trade-war levels, and implemented global steel and aluminium duties. The Fed’s upward revision to its inflation forecast “partially reflects the expected impact of recently implemented US tariffs and consequential retaliation,” as the March statement noted.

Tariffs present a unique challenge for monetary policy. They function as a supply-side shock: they raise prices for consumers and businesses without generating additional economic activity. Raising rates in response to tariff-driven inflation would compound the economic pain by tightening financial conditions on top of an already restrictive trade environment. Cutting rates would risk validating the price increases and potentially triggering a wage-price dynamic that embeds the tariff shock into the broader inflation picture.

The Fed’s response is to do neither: hold rates steady and wait for the tariff landscape to stabilise before making any further adjustment. This is intellectually defensible but practically uncomfortable. Businesses need certainty about the cost of capital to make investment decisions. Consumers facing higher prices from tariffs would benefit from lower borrowing costs. The Fed’s patience is a luxury that the real economy may not share.

The Dot Plot and Market Expectations

The March dot plot maintained the projection of two rate cuts in 2025, unchanged from the December meeting. But the composition shifted: fewer Committee members projected more than two cuts, while more members projected no cuts at all. The median projection masks a widening distribution of views that reflects genuine uncertainty about the economic outlook.

Market expectations have adjusted accordingly. Fed funds futures, which at the start of the year were pricing four to five cuts in 2025, have pulled back to approximately two to three cuts, with the first not expected until June at the earliest. The repricing has been orderly, reflecting the market’s acceptance that the Fed’s data-dependent framework requires patience rather than pre-emptive action.

Quantitative Tightening: A Stealth Easing

In a development that received less attention than the rate decision, the Fed announced it would further slow the pace of quantitative tightening starting in April, reducing the monthly cap on Treasury securities redemptions from $25 billion to $5 billion. This represents a near-cessation of Treasury QT and is the latest step in a gradual unwinding of the balance sheet reduction programme that began in 2022.

The decision reflects growing concerns about tightness in reserve markets. Repo rate volatility had been increasing, and the Fed’s staff analysis indicated that reserves, while still within the “ample” range, were approaching levels that could create funding pressures. By slowing QT, the Fed is easing one dimension of policy while holding another steady, a nuanced approach that allows it to maintain the headline rate stance while reducing the risk of a liquidity squeeze in funding markets.

What the Market Is Misunderstanding

The pause is not a prelude to imminent cuts. The market’s pricing of two to three cuts in the second half of 2025 may prove optimistic if inflation remains elevated. The March SEP revision to 2.8% core PCE is not consistent with a central bank that is confident about cutting rates. Unless inflation declines meaningfully from current levels, the Fed may hold rates at 4.25-4.50% for longer than the market expects.

The labour market’s resilience is being tested, not confirmed. The upward revision in the unemployment forecast to 4.4% acknowledges that the labour market is softening. The question is whether the softening stabilises at a level consistent with full employment or accelerates into a more meaningful deterioration. If the latter, the Fed will face pressure to cut rates even if inflation remains above target, forcing the kind of dual-mandate trade-off that no central banker wants to make.

QT reduction is the under-reported story. The near-cessation of Treasury QT is a significant easing of financial conditions that is being drowned out by the rate hold narrative. For fixed income markets, the reduction in Treasury supply from the Fed’s balance sheet runoff is supportive of valuations and reduces the risk of the kind of funding market stress that triggered the repo crisis of September 2019.

Implications for Investors

The rate environment is stable but not accommodative. With the fed funds rate at 4.25-4.50% and the pause likely to persist for at least two more meetings, the cost of capital remains elevated relative to the 2020-2021 environment. Companies with variable-rate debt and refinancing needs face sustained pressure. Investment-grade credit and short-duration fixed income remain attractive on a yield basis.

The stagflationary risk is real. The combination of rising inflation and rising unemployment, even if modest, creates an environment in which neither growth stocks (which need falling rates) nor cyclical stocks (which need accelerating growth) are well-supported. Defensive sectors with pricing power, dividend growth, and low cyclical exposure deserve increased attention.

Gold benefits from the dual-mandate tension. Gold’s appeal increases when the Fed faces an impossible choice between fighting inflation and supporting employment. The current environment, in which both sides of the mandate are under pressure simultaneously, is structurally supportive of gold regardless of short-term price fluctuations.

Watch for the data to force the Fed’s hand. The March pause is a holding pattern, not a policy equilibrium. The data that emerges over the coming months, particularly employment, inflation, and the economic impact of tariffs, will determine whether the next move is a cut (if the labour market deteriorates significantly) or a prolonged hold (if inflation remains sticky). Position portfolios for both scenarios rather than betting on one.

Conclusion

The Fed’s March hold confirms that the easing cycle has stalled and “higher for longer” has returned, this time driven not by the fight against pandemic-era inflation but by the stagflationary uncertainty created by the tariff regime. The Committee is caught between an inflation mandate that argues for maintaining restrictive policy and an employment mandate that may soon argue for easing. Until the tariff picture clarifies and the data resolves this tension, patience is the only viable policy, even if it is not a comfortable one.

Related Reading

The Fed’s pause followed the cuts covered in Fed Cuts Again: Three Consecutive Cuts. For the tariff-driven inflation pressures that complicated the outlook, see Trump’s Tariff Blitz. For the eventual next move, see Fed Holds Amid Iran War. For the Fed’s return to hawkish rhetoric in 2026, see The Return of the Hawk.

Related Reading: see the Warsh doctrine and the April FOMC.