The Fed has split into two camps over future interest rate path, BCA Research says

Investing.com - The Federal Reserve’s latest interest rate projections show that policymakers have largely split into two camps, according to analysts at BCA Research.

In a note to clients, the analysts flagged that seven participants on the rate-setting Federal Open Market Committee are expecting no interest rate cuts this year, while eight are anticipating 50-basis points in reductions by the end of 2025.

The first group is placing greater emphasis on the risk that President Donald Trump’s sweeping tariff agenda will spur a sustained uptick in inflationary pressures within the next couple months, while the second believes the impact of the levies will be more "transitory," the strategists said.

The analysts added that they fall more into the second line of thinking, arguing that while they "fully expect to see tariffs impact inflation more meaningfully [...] the fact that prices were so well contained in May suggests that firms aren’t looking for any excuse to lift prices and will only do so reluctantly once tariffs force their hands."

"This is not the sort of environment where you would expect an expectations-driven inflation spiral to emerge," the analysts said.

On Wednesday, the Fed chose to leave interest rates steady at a range of 4.25% to 4.5% following the conclusion of its latest two-day meeting, although official projections indicated that policymakers still expect to draw down borrowing costs this year.

In an update to its all-important "dot plot", two 25-basis point rate cuts were broadly seen this year, matching prior predictions in March and December. Yet the pace of reductions next year and in 2027 was slowed, signalling that the Fed could be gearing up for a longer fight to bring inflation down to its 2% target.

Chair Jerome Powell warned that the impact from Trump’s tariff push is likely coming, and could lead to a "meaningful" uptick in consumer price growth.

Powell added that "no one holds these [...] rate paths with a great deal of conviction." Many economists have recently said that Trump’s punishing levies could refuel inflationary pressures, dent labor demand and weigh on wider activity.

Policymakers now anticipate that inflation will end 2025 at 3%, above its current level, while growth is tipped to decelerate to 1.4% and unemployment is expected to edge up to 4.5%. The projections paint a picture of relatively modest stagflation, a period of elevated prices and tepid economic activity.

Following the announcment, the BCA Research analysts recommended that bond investors maintain "above-benchmark portfolio duration on a cyclical investment horizon and hold duration-neutral 2-year/10-year Treasury curve steepeners."

"We also continue to hold a tactical short position in the January 2026 fed funds futures contract," they said.