The Federal Open Market Committee’s recent dot plot predicts interest rates will average 3.9% by the end of 2025. This could involve two 25 basis point rate cuts or a single 50 basis point cut in 2025. Rates are expected to rise to 3.6% in 2026 and 3.4% in 2027, with a longer-term forecast remaining at 3%.
The Federal Reserve has adjusted its economic projections. US GDP is projected at 1.4% for this year, down from 1.7% previously. In 2026, the economy is expected to grow by 1.6%, slightly less than the 1.8% forecast in March.
Unemployment Outlook
The unemployment rate is anticipated to rise to 4.5% by the end of 2025. For 2026, it is estimated to remain at 4.5%, surpassing the March projection of 4.3%.
PCE inflation is projected to reach 3% this year, up from 2.7%. By 2026, inflation might ease to 2.4%, still above the earlier 2.2% prediction. The PCE index is expected to be 2.1% by 2027, with core PCE revised to 3.1% for 2025 from 2.8%.
Taken together, the Federal Reserve’s revised outlook suggests a more measured easing cycle, with interest rates settling higher than previously assumed. The dot plot shows only modest downward adjustments to the policy rate over the next few years, despite lowered growth expectations and increased inflation projections. That tells us they’re not yet convinced inflation risks have receded enough to move more aggressively.
The projected year-end rate of 3.9% for 2025 implies either two small cuts or one larger one. Compared to nine months ago, the potential for quick, repeated rate reductions feels far less likely. If anything, the path seems flatter. But it’s that steady trajectory that tells us the Fed doesn’t want to let go of tight policy prematurely—not while inflation remains above target across multiple timelines.
The market is being asked to believe that growth will slow, the labour market will weaken, and inflation will moderate—but not fast enough to prompt the kind of sweeping intervention some had hoped for. What we see is a message that they are prepared to wait. Powell cannot commit to dovish action until inflation data reflects persistent change rather than monthly variation.
Inflation and Economic Implications
In that sense, the recent upward revision to both headline and core PCE matters more than the GDP downgrade. It’s about the sequencing and size of surprises over time. The central bank sees inflation returning to target over a three-year window, rather than rushing toward 2% in the next four quarters. That increases the probability of extended periods with rates well above neutral.
Unemployment expectations also carry weight here. The higher forecast points to a softening in the jobs market, but not a collapse. A gentle upward drift to 4.5% may reflect delayed effects of prior tightening rather than new shocks. It might also be a signal that rates are being kept high enough to slow job creation on purpose—an approach we’ve seen before in the early 2000s.
For those of us running exposure to interest rate volatility, it’s worth noting how anchored the long-run rate remains at 3%. That alignment creates pressure in the belly and the wings of the yield curve and raises implied volatility around 2025–2026. The path between now and there is where uncertainty gathers—and where we might find asymmetry.
Careful attention should also be paid to what’s *not* adjusting. The Fed’s longer-term inflation assumptions have barely moved, even though short-term figures have come in hotter-than-expected. That suggests confidence in the framework, not the data. If higher inflation persists, they may be forced to reconsider this stance sooner than indicated.
In the near term, we should watch the divergence between realised inflation and market-based expectations. The Fed’s preference for gradualism makes front-end pricing more sensitive to data surprises, especially those tied to monthly inflation reports and labour market dynamics. This is where convexity can work in our favour.
Volatility markets are starting to reflect this tug-of-war. Implied rates volatility has bounced, particularly in shorter-dated tenors, but remains far below last year’s peaks. That’s a choice, not an accident. The Fed’s caution has narrowed the debate to a narrower path. But policy missteps—or unexpected persistence in inflation—could widen that very quickly.
This is not yet a pivot. It’s more of a pause, with a forward glance. Dislocations may be temporary, but they offer opportunities where timing can be synchronised with data—especially if terminal rate assumptions continue being pushed up at a time when expectations were leaning the other way.
From where we sit, the assumption of policy normalisation remains just that—an assumption. Those expecting rapid easing might need to reassess exposure, particularly at the front end. Carry remains positive, but drift could vary widely. It will come down to how much patience the Fed actually has—versus how much it can afford.
