U.S. Interest Rate Outlook: A Detailed 3–6 Month Forecast (H2 2025)

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The U.S. interest rate environment is at an inflection point. As we enter the second half of 2025, the Federal Reserve faces an unusually complex policy landscape. While inflationary pressures have moderated from their post-pandemic peaks, a range of countervailing forces — including renewed tariffs, fiscal expansion, geopolitical volatility, and conflicting economic data — complicate the decision to pivot from a restrictive to a more accommodative monetary stance. This paper presents a detailed examination of the key macroeconomic and political drivers shaping interest rate policy over the next 3 to 6 months.

 

Interest Rate Outlook and Inflation

The Federal Reserve has justifiably maintained a cautious tone in its monetary policy stance. With the federal funds target range currently set between 4.25% and 4.50%, any near-term shift is highly conditional not only on incoming economic data, but more importantly the navigation and execution of a series of fiscal policy decisions looming over the coming months.

The most recent sets of data support the argument that the FED has room to ease policy; however, much of this data needs to be taken in the context of recent US Trade Policy headlines and business reactions.  Despite falling headline inflation and signs of economic cooling, the Fed remains concerned about underlying inflationary pressures, particularly within the service sector. Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, has remained sticky around 2.6-2.7%.  This persistence stems largely from ongoing strength in shelter costs and wages, which have proven more resistant to disinflationary trends.  This may be changing however, as several markets are starting to show significant decay in decay in shelter costs.  It will take some time for this reduction to trickle into the PCE but deflationary forces are likely underway.

At the same time, the labor market, while still strong by historical standards, has shown signs of softening – but anecdotally as well as in the numbers. The unemployment rate has begun a gradual upward drift toward 4.2%, and wage growth, while still solid, has started to moderate. Yet, real wage gains continue to exceed productivity growth, thereby keeping some upward pressure on inflation. Meanwhile, Real GDP has fallen more than expected in Q12025, decreasing at an annual rate of 0.5%.  The lowered estimate reflected an increase in imports, likely in response to Q1 and Q2 fears of (then) potential tariffs. 

These evolving trends create a policy environment in which a 25 to 50 basis point rate cut remains plausible by late Q3 or early Q4.  The data is likely to be mixed and, on the margin, more supportive of interest rate reductions.  The calls for FED action will grow louder and stronger, but the Fed’s decision-making will likely hinge less on the data and more heavily influenced by updates on US Trade Policy.

Tariffs and Trade Policy Deadlines

Beginning this year, we saw tariffs returning as a focal point of U.S. economic policy. The Trump administration introduced new levies on strategically sensitive imports such as electric vehicles, microchips, and solar components from China, while enacting blanket tariffs on most goods from nearly all countries across the globe.  The market response, both in the equity and rates space, was violent – and while much of the volatility has abated, it is important to note that this has occurred due to the current 90-day “pause”.  The medium and long-term economic impact of these decisions has yet to be determined. 

The inflationary implications of these tariffs are nuanced. On one hand, if American consumers and businesses continue to demand these higher-priced imports without adjusting their consumption patterns, the tariffs will increase inflation, particularly in durable goods and technology sectors. On the other hand, if demand falls or supply chains diversify to more cost-effective producers, the tariffs could exert a deflationary force. The outcome depends largely on consumer behavior, substitution effects, and the resilience of global supply chains.

Federal Reserve Under Increasing Political Pressure

The Federal Reserve operates in an environment increasingly influenced by political and public scrutiny. With the 2024 election cycle complete, the Fed has regained some measure of independence, but the calls for monetary easing have grown louder across the political spectrum. Lawmakers from both parties are highlighting the affordability crisis in housing and rising consumer debt burdens as reasons to reduce rates.

To date the Fed has not allowed these calls to sway its decision-making.  At the latest meetings Chair Powell reaffirmed the FEDs tight monetary policy despite falling inflation, instead introducing the unknown inflationary impacts of tariffs and US trade policy as a potential preventative measure to interest rate cuts.  The Fed appears to be pivoting not in their policy stance, but in their rationale for monetary policy action.

Given this latest change in tone and emphasis, it seems unlikely that the Fed will cut rates until there is a clear view on tariffs, and trade deals are negotiated.

Market expectations diverge somewhat from official guidance. While futures markets are pricing in one to two rate cuts before the end of the year, there are other critical factors such as US debt ceiling, tax policy, and political pressure to replace Powell as FED chair that are likely to impact the interest rate curve over the next few months, particularly in the long end.  The recent move lower and general “melt-up” in risk assets over the past few weeks only sets the table for a corresponding opposite move should the administration fail in any of their policy plans.

Government Debt Ceiling and Fiscal Expansion

Fiscal dynamics are exerting a growing influence on interest rate policy. A short-term agreement passed in April 2025 delayed the debt ceiling debate, but with its expiration scheduled for November, markets are bracing for renewed political brinkmanship. Any sign of dysfunction or potential default could cause volatility in Treasury markets, particularly at the short end of the yield curve.

Beyond the ceiling itself, the scale of Treasury issuance to finance the federal deficit is becoming a policy constraint. With monthly bond sales topping $120 billion, the sheer volume of debt entering the market is placing upward pressure on yields. In effect, the market’s response to fiscal policy is tightening financial conditions independently of the Fed's own actions.

Liquidity conditions are also shifting. A decline in reverse repo balances signals reduced excess liquidity in the financial system, and elevated term premiums suggest investors are demanding higher compensation for holding long-duration assets. These trends could dampen the efficacy of any future rate cuts on the belly and long end of the curve, potentially forcing the Fed to adjust its balance sheet policies in tandem.

Upcoming Debt Issuance and Rollover

In addition to the ongoing challenges of deficit financing, a significant schedule of debt issuance and rollover is slated for the remainder of 2025. The Treasury Department plans to issue a consistent monthly volume of both 10-year and 30-year bonds through December. These auctions reflect both rollover of maturing debt and the need to raise new cash.

The table below summarizes the expected issuance:

Month	10-Yr Issuance	Rollover (93%)	New Cash (7%)	30-Yr Issuance	Rollover (93%)	New Cash (7%)
July	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B
August	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B
September	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B
October	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B
November	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B
December	$42B	$39.06B	$2.94B	$22B	$20.46B	$1.54B

This steady issuance pattern will test the bond market’s capacity to absorb supply without demanding higher yields. The composition of each issuance, with only 7% designated as new cash, underscores how much of this activity is dedicated to refinancing existing obligations rather than expanding fiscal outlays. Still, the incremental demand for $4.48 billion in new cash each month across both maturities may exert modest upward pressure on long-term rates if investor appetite weakens.  It is critical that markets normalize ahead of this issuance as any new supply coming at a time of domestic dysfunction or economic uncertainty could lead to a meaningful increase in yields. 

A potential positive development which could lead to meaningful decrease in yields despite this new issuance and rollover, are regulatory changes that would either allow – or force – entities to purchase USTs in meaningfully different sizes as a regulatory requirement.  We may also see deregulation or new incentives given to banks to allow expanded lending to the private sector which would make banks better buyers of USTs in response.

Tax Policy: The "Big, Beautiful Tax Bill" Revisited

Tax policy is poised to become a central issue in the economic debate.  The expiration of several key provisions of the 2017 Tax Cuts and Jobs Act (TCJA) at the end of the year presents both an opportunity and a challenge for lawmakers and Fed officials. Early drafts of the legislation have driven a stake between members of Congress, but the latest news looks like the President and his administration are winning over the dissenters.  In its current form the “Big, Beautiful Tax Bill” is nuanced – on the one hand it is likely to increase real wages and as such it increases affordability for certain demographics.  On the other hand, it is highly likely that this increase in wealth effect will lead to broad based asset appreciation and inflation across the board, passing-through to inflation as shelter prices and cost of goods increase. 

Three potential scenarios:

1. The most likely outcome is an extension of the TCJA without offsetting spending cuts.  This would likely worsen the fiscal deficit, pushing bond yields higher.

   
   

2. A compromise involving tax extensions paired with targeted spending reductions might be more fiscally palatable but could slow economic growth in the short term.

   
   

3. Allowing the TCJA provisions to sunset—appears politically unlikely but would entail significant tax hikes for individuals and small businesses, potentially dampening consumption and investment.

Financial markets will respond to the perceived fiscal discipline (or lack thereof) of the final package. Expectations of further deficit expansion will steepen the yield curve, while a credible long-term fiscal plan could ease upward pressure on interest rates. Either way, the legislative outcome will have important implications for the Fed's policy calculus.  Remember, tax cuts are not always a good thing for the long-term health and viability of a country’s economy if they come at the expense of long-term fiscal responsibility.

Geopolitical Risk Factors

Global instability continues to cast a long shadow over the economic outlook and introduce a range of economic risks. Oil prices have had a volatile year, ranging from $58 to $80 per barrel, and are expected to spike aggressively if there is any disruption to the Strait of Hormuz following the US bombing of Iranian nuclear facilities.  Agricultural commodities, though currently well-supplied, are vulnerable to both geopolitical and climate-related shocks. 

Geo-political tensions can, however, have a positive impact on U.S. Treasuries, as they traditionally benefit from flight-to-safety flows during periods of global stress. However, this safe-haven effect is counterbalanced by the inflationary consequences of supply-side disruptions. As such, geopolitical volatility can simultaneously increase demand for Treasuries while complicating the Fed’s inflation-fighting efforts.

Market-Based Scenarios

Given the range of uncertainties, market participants are preparing for multiple potential outcomes. The base case envisions a modest decline in inflation and a single 25 basis point rate cut by the Federal Reserve in September. In this scenario, core inflation drifts below 2.5% by the end of Q4, and Treasury yields stabilize in the 3.75% to 4.25% range.  We do not expect a meaningful move in the long-end of the curve in this scenario, though it is likely some of that 25bps cut extends into the 30Y.

A more hawkish scenario assumes that inflation proves more resilient due to continued wage pressure and tariff-related price increases. That, or the lack of progress in trade deals, means leaves the threat of tariff driven inflation on the table and as a result the Fed holds rates steady through year-end, and the 10-year yield rises toward 4.75%.

A dovish alternative anticipates a sharper economic slowdown and increased recession risks. This outcome could prompt the Fed to deliver two rate cuts before year-end, leading to a decline in Treasury yields to around 3.5%. However, such a scenario may sow the seeds for renewed inflationary pressures, especially if the cuts stimulate demand prematurely. In this context, the Fed could find itself needing to reverse course and reintroduce rate hikes within the following year or two to counteract a resurgence of inflation sparked by an overly accommodative stance.

Conclusion

The Federal Reserve and the broader U.S. economy are navigating a precarious and interdependent set of risks. While inflation has come down significantly from its peak, it remains above the Fed’s comfort zone and the uncertainty surrounding US trade policy is likely to delay aggressive Fed response to any particular data set.  Meanwhile, political, fiscal, and geopolitical pressures are combining with macroeconomic fundamentals to create a uniquely challenging policy environment.

The decisions made over the next several months will determine whether the U.S. begins a new easing cycle or remains in a period of prolonged monetary restriction. Investors, businesses, and policymakers alike must remain vigilant, continuously evaluating the intersection of data, policy, and global developments to make informed strategic decisions. 

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