Stay Tuned: Fed in Focus — July 2025 FOMC Preview, 29 July 2025

As markets prepare for the Federal Reserve’s upcoming FOMC meeting this Wednesday, investors must contend with a macro landscape that includes persistent inflation, a gradually cooling labour market, new tariff risks, and signs of economic contraction. This report explains the importance of the Fed’s inflation target, especially recent PCE data, and explores three policy options with potential impacts for commodities, equities, and forex. The uncertainty and key data will lead to a more volatile market, which could lead to attractively priced autocallables.

Fed Chairman Powell (Source: BBC)

Inflation Measurement: Why PCE, Not CPI?

Understanding why the Federal Reserve targets the Personal Consumption Expenditures (PCE) price index, rather than the Consumer Price Index (CPI), is crucial for interpreting current policy moves.

The PCE price index covers a broader array of consumer expenditures than the CPI, which mostly considers out-of-pocket spending by urban households. PCE includes rural and urban consumers, reflects employer-paid healthcare and government-provided benefits, and also captures spending by non-profit institutions serving households. This wider scope allows the PCE to provide a more holistic snapshot of cost-of-living adjustments for all consumers.

Another key difference is that the PCE uses dynamic weighting: it updates its basket compositions and weights monthly, capturing real-time adjustments as consumers substitute between goods when prices change. In contrast, CPI weights are updated only infrequently, typically once a year, which makes them less responsive to changes in consumer behaviour during rapidly shifting macro conditions.

Moreover, PCE data are sourced primarily from business and administrative records, rather than mainly from consumer surveys as in the CPI. This methodological distinction tends to make PCE less volatile month-to-month, favouring it as a more stable signal for policymakers.

Because of these features, the CPI consistently reports higher inflation rates than the PCE index. For example, in June 2025, headline CPI inflation was 2.7%, whereas the PCE inflation figure, published with a lag, tends to be lower.

Chart of the United States PCE Price Index Annual Change Over the Past 5 Years (Source: Trading Economics)

Looking more closely at recent PCE data: after reaching a sharp peak of 7.2% annual inflation in June 2022 — driven by pandemic-related disruptions and supply chain constraints — the yearly PCE inflation rate has moderated markedly. It has remained at or below 3% since October 2023 and, so far in 2025, has stayed consistently within the 2–3% range. The latest official PCE inflation report showed a 2.3% rise for May 2025. The crucial June 2025 PCE data will be released on the 31st of July, just one day after the FOMC meeting, underscoring its importance for future Fed guidance.

The Fed’s 2% inflation target is formally based on this comprehensive and adaptive PCE price measure, reflecting its central role in the policymakers’ framework.

Fed Policy: On the Cusp of Decision

The Federal Reserve has kept the federal funds rate steady at 4.25–4.50% since December 2024, balancing its dual mandate of controlling inflation while supporting economic growth. Recent macro data paint a nuanced picture: June’s CPI inflation rose modestly to 2.7%, and unemployment has remained soft at around 4–4.2%, indicating a labour market that is easing but not sharply deteriorating.

Chart of the United States GDP Growth Rate Over the Past 5 Years (Source: Trading Economics)

A key development complicating the Fed’s decision is economic growth. According to the U.S. Bureau of Economic Analysis (BEA), the U.S. economy contracted at an annualised rate of 0.5% in the first quarter of 2025 (Q1 2025), a sharper decline than the previous estimate of a 0.2% decrease. This marked the first quarterly GDP contraction in three years and was driven largely by downward revisions to consumer spending and exports. This clear signal of growth headwinds adds pressure on Fed policymakers as they weigh whether to loosen policy despite inflation risks.

Adding to uncertainty, the new tariffs announced by President Trump are set to take effect on the 1st of August, potentially adding upward pressure on prices. Chair Jerome Powell mentioned this risk in June and projected that core PCE inflation could climb as high as 3.1% by year-end.

Further complexity arises from the data calendar: the first estimate of Q2 2025 GDP will be released on Wednesday 30th of July, approximately 6 hours and 30 minutes before the FOMC interest rate decision. Meanwhile, the Fed’s preferred inflation metric, the June PCE price index, will not be available until 31st July — the day after the meeting. Given this timing, the Fed is expected to adopt a data-dependent, cautious approach, waiting for more information before making a decisive policy shift.

In summary, the Fed faces a delicate balancing act: inflation risks from tariffs and supply shocks, the cooling but still stable labour market, and emerging evidence of slowing growth. This complex backdrop supports expectations for either a pause in policy or, if growth data further deteriorates, a cautious easing.

Scenarios for the July FOMC Meeting

Option 1: No Change in Rates

Should the Fed leave rates steady, it would signal continued vigilance against inflation risks and a desire for confirmation of disinflation before considering rate cuts.

Implications:

• Commodities: Persistently elevated rates alongside trade disruptions could keep commodity prices volatile yet supported, especially energy and metals, due to supply constraints and geopolitical risk. This environment mitigates the negative aspects for commodity producers and commodity-linked structured investments.
• Equities: Small caps, such as those in the Russell 2000, may continue to face headwinds from constrained borrowing conditions, tight credit, and margin pressure. Large caps with pricing power and global diversification may outperform, but broad equity gains might stall until easing arrives.
• Forex: The US dollar would likely remain firm, underpinned by relatively high real rates and risk aversion. Structured strategies in currency pairs where macro themes prevail — such as CAD/JPY — can be effective for managing risk and capturing directional moves amid policy divergence and commodity strength.

Option 2: Rate Cut by 25 or 50 Basis Points

If the incoming data — particularly Q2 GDP and PCE inflation — suggest a significant economic slowdown or easing inflationary pressures, the Fed could opt to cut rates.

Implications:

• Commodities: Lower borrowing costs could boost industrial and consumer demand, supporting prices across energy, metals, and agriculture. Easing may also increase inflation expectations, benefiting commodities as an inflation hedge.
• Equities: A Fed pivot could ignite a rally in small caps, historically sensitive to interest rate cuts, by relieving debt burdens and restoring investor confidence. Sector selection remains crucial, focusing on companies with strong balance sheets and domestic revenue exposure to capitalise on cyclical recovery.
• Forex: Fed easing would likely weaken the US dollar, favouring commodity-linked currencies like CAD and creating opportunities in FX structured products (e.g., CAD/JPY autocallables) that offer attractive yields in turbulent markets.

Option 3: Rate Cut of 25 Basis Points Plus Quantitative Tightening

A more nuanced, less discussed third scenario would involve the Fed cutting the fed funds rate by 25 basis points while simultaneously conducting quantitative tightening (QT) in a manner approximating 25 basis points of tightening. QT entails the Fed reducing its balance sheet by allowing assets like Treasury securities and mortgage-backed securities to mature without reinvesting proceeds — effectively draining liquidity from the financial system, the opposite of quantitative easing (QE).

This combination would represent a sort of “mixed policy” approach: loosening short-term interest rates modestly to support growth while maintaining tight overall financial conditions to combat inflation risks.

Implications:

• Commodities: The dual approach should keep liquidity relatively tight, preventing runaway commodity price inflation while avoiding excessive economic contraction. Commodity prices could remain supported but less volatile than in outright easing.
• Equities: Small and mid-cap equities may see a balanced effect. Rate cuts ease borrowing costs, helping sentiment, but QT constrains liquidity, possibly capping rallies. Investors would benefit from selective exposure focusing on quality and sectors less dependent on excessive liquidity.
• Forex: This “split” approach could produce mixed currency signals. The dollar might not weaken fully as QT offsets some or all of the rate cut easing. Commodity currencies like CAD may gain moderately, but FX volatility could increase. Structured products that manage both directional exposure and risk, such as autocallables, would be useful in this environment.

GDP: A Key Catalyst for each Scenario?

While the market views steady policy (Option 1) as most likely, the GDP growth rate release on the day of the FOMC meeting is a pivotal market driver. With Q1 2025 registering an annualised contraction of 0.5%, a second consecutive negative reading for Q2 would fit the textbook definition of a “technical recession.” However, it is essential to note that official recessions in the United States are not declared by GDP alone.

The National Bureau of Economic Research (NBER), the recognised arbiter of U.S. business cycles, defines a recession as a significant decline in economic activity, spread across the economy, and lasting more than a few months. Rather than relying purely on GDP, NBER gives the greatest weight in recent decades to two high-frequency measures: real personal income less transfers and nonfarm payroll employment.

• Real personal income less transfers, as reported by the U.S. Bureau of Economic Analysis (BEA), fell by 0.4% in May 2025, its first decrease since September 2021. This dip was driven by declines in government social benefits and farm income, partially offset by increased employee compensation. This contraction signals that household fundamentals have weakened somewhat.
• Nonfarm payroll employment, according to the U.S. Bureau of Labor Statistics (BLS), continued to exhibit resilience through June, supporting the narrative of a still-stable labour market. However, headwinds — including tariff uncertainty and shifting trade and immigration policy — may prompt employers to slow hiring, which could change this outlook in the coming months.

Chart of the United States Non Farm Payrolls Over the Past 5 Years (Source: Trading Economics)

Thus, even if Q2 2025 GDP contracts, an official recession call would require confirming broad-based weakness in both real personal income (excluding government transfers) and employment. So far, the data suggest a nuanced scenario: economic growth is softening, but not all core indicators signal a full recession. Investors and policymakers therefore must look beyond headline GDP, closely tracking these key components as catalysts that could shift the Fed’s stance — and market sentiment — across any of the three outlined policy scenarios.

PCE: The Continuous Anchor

The trajectory of PCE inflation is critical for Fed forward guidance. Its continued moderation since 2022, currently around 2.3% for May, aligns with the Fed’s objectives. However, the impending June PCE figure release the day after the meeting means Fed policymakers will likely lean on cautious, data-dependent language until more information arrives.

Conclusion

The July 2025 FOMC meeting arrives at a juncture of stabilised inflation, early signs of economic contraction, tariff-induced price pressures, and a labour market that is gradually easing. While the possibility of a technical recession is real if Q2 GDP contracts, it is important to recognise that official recession determination hinges on broader and more persistent declines in real personal income (excluding transfers) and nonfarm payroll employment — both of which currently present mixed signals. Against this multifaceted backdrop, the Fed’s cautious, data-dependent posture remains warranted, with upcoming GDP and PCE inflation data providing crucial context just before and after the decision.

For investors, navigating this complex environment calls for a disciplined, multi-dimensional approach. Monitoring the full range of macro indicators — not just headline GDP — will be key to identifying genuine turning points in Fed policy and market direction. Strategic allocations should emphasise fundamentally resilient commodity exposures, selective small-cap equities with strong balance sheets and domestic revenues, and structured FX strategies designed to hedge divergence and volatility. Maintaining a data-driven, risk-aware stance is essential for capturing tactical opportunities while guarding against downside scenarios.

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Hi, my name is Alex, and this is a thought piece called “Stay Tuned,” on one topic where there is a macro turning coming soon. If you like what you read, please hit the “like” button and follow me.

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