US Inflation Dampens Rate Cut Expectations, Dollar Holds Steady Amid Tariff Overhang

US inflation data for June has prompted market participants to scale back expectations of multiple interest rate cuts by the Federal Reserve in 2025. Although a September rate reduction is still on the table, its likelihood has been meaningfully downgraded. Strong labor market data earlier this month already tempered expectations, but with signs now emerging that tariff related costs are being passed through to consumers, the Fed is likely to adopt a more cautious stance.

Traders now expect fewer policy adjustments from the US central bank this year, contributing to a mildly supportive environment for the dollar. However, the outlook remains clouded by political pressure on the Federal Reserve, particularly surrounding the potential replacement of Chair Jerome Powell. The result is a delicate balancing act for FX markets, the dollar is holding firm in the near term, but risks remain tilted to the downside if credibility concerns around US monetary policy intensify.

Key Macroeconomic and Policy Developments

1. Tariff Pass Through Effects on Inflation
June’s CPI data confirmed that businesses are beginning to shift tariff related costs onto consumers. While the overall inflation profile remains contained, this subtle pass through effect is enough to delay any near term rate cuts. Markets now assume the Fed will stay on the sidelines through the summer, at least until signs of disinflation or labor market weakness emerge more clearly.

2. Fed Rate Outlook Reassessed
The probability of a rate cut in September, which was nearly fully priced just weeks ago, has fallen back to just above 50%. With the July 30 FOMC meeting unlikely to deliver any change, attention turns to forward guidance and September’s meeting, which now represents a critical inflection point. The Fed remains data dependent, and any deterioration in job growth or inflation moderation could rekindle expectations of easing.

3. Political Pressure on the Fed
Markets are increasingly sensitive to the evolving political narrative around the Fed’s leadership. Treasury Secretary Scott Bessent’s comments hinting that Powell should step aside in 2026 have stirred speculation, while reports that Kevin Hassett is the frontrunner to replace him suggest a potentially more politically aligned central bank under the Trump administration. Such developments could undermine institutional independence and fuel renewed market volatility.

Financial Markets and FX Strategy Implications

In the fixed income space, US Treasury yields are beginning to reflect the diminished likelihood of near term rate cuts. Bearish sentiment is returning as concerns over sustained inflation and aggressive fiscal spending weigh on investor appetite for duration.

In the foreign exchange market, the dollar remains broadly supported in the short term by the Fed’s more cautious stance. The shift in rate expectations provides a tailwind, particularly against currencies where central banks are closer to easing or face weaker economic data. However, this support could prove temporary.

FX traders should remain alert to three unfolding themes:

• First, any re-acceleration of inflation whether from tariffs or other sources would likely reinforce the Fed’s cautious approach and extend the dollar’s near-term strength.
• Second, should the labor market show signs of softening over the coming months, expectations for policy easing may resurface rapidly, putting downward pressure on the greenback.
• Third, political risk related to the Fed’s leadership could become a major inflection point. If markets begin to doubt the Fed’s independence or anticipate a more dovish appointee, a sell off in the dollar and US Treasuries could materialize.

Conclusion

US macroeconomic data is now pushing back against premature expectations of monetary easing. While the broader inflation trend remains relatively stable, the initial pass-through of tariff related price pressures has complicated the near-term policy outlook. As a result, the Fed is expected to pause, with September now seen as a potential but far from guaranteed moment for action.

The dollar is likely to remain underpinned in the short term, but medium-term risks are building beneath the surface. Political pressure on the Fed, combined with the unpredictable trajectory of trade policy, means currency markets may experience renewed volatility in the weeks ahead. Traders are advised to monitor developments closely, particularly any emerging signals of economic softening or political escalation in Washington that could reframe the Fed’s trajectory.