Macro Signposts | 22 July 2025

Long View on the Fed: A Return to Neutral

I'd like to thank Libby Cantrill, PIMCO's head of public policy, for her contributions to this edition.

Despite heightened political noise surrounding the Federal Reserve, we do not anticipate dramatic shifts in monetary policy - regardless of who is confirmed as the next chair. A Trump-appointed candidate would likely favor a faster return to a neutral policy stance than the current median view of the Federal Open Market Committee (FOMC). They may also support a more aggressive approach to balance sheet normalization, with an emphasis on gradually shifting the Fed's holdings toward Treasury bills.

While Trump's nominees for Fed chair would likely advocate for a faster pace of rate cuts, the administration's optimistic growth forecasts limit the case for a policy stance below neutral or for adopting a much lower estimate of the neutral rate than the current FOMC consensus.

Furthermore, despite ongoing speculation, we believe it is highly unlikely that Trump will fire Fed Chair Jerome Powell before his term ends in May 2026. Firing Powell could be self-defeating in several respects, and besides, the legal, political, and economic ramifications loom too large. (For a more detailed analysis, see the article by my colleague and former Fed Vice Chair Richard Clarida in last month's Economist, titled "The best check on Fed politicisation is fear of being judged a failure.")

Overall, we believe a reasonable path forward given our economic outlook is a return to a neutral policy stance by the end of 2026, with interest rates settling near the midpoint of the Fed's estimated neutral range of 2.6%-3.6% (down from the current level of 4.25%-4.5%). This is lower than the FOMC's current 2026 Summary of Economic Projections median projection of 3.6%, but it remains within the central tendency range. So far, consumer price adjustments resulting from higher tariffs have been mild. If that trend continues, there is a strong case for the Powell-led FOMC to resume normalizing rates later this year.

Interest rates could reach neutral next year
Many investors are asking about the direction of Fed policy, particularly in light of Trump's public dissatisfaction with recent decisions under Powell and next year's expiration of key Fed appointments. In our view, economic fundamentals and institutional dynamics point to a baseline monetary policy outlook that is not meaningfully different from what would be expected with the current composition of FOMC participants - perhaps with a marginally faster return to a more neutral policy stance.

Amid the headlines surrounding Trump and Powell, recent economic data developments are strengthening the case for rate cuts. U.S. economic momentum has slowed compared to last year: Department of Commerce data show real consumption growth of approximately 1% in the first half of 2025, down significantly from the 4% pace recorded in the second half of last year. Inflationary pressures have also been milder than expected - partly because tariffs are taking time to filter through to consumer prices (see last week's Macro Signposts, "The Economic Impact of U.S. Tariffs"). Some policymakers, including Fed Governor Christopher Waller, have made a case for an earlier move in July, while 10 FOMC participants expect two or more 25 basis-point cuts later this year.

The individuals speculated to be leading contenders to succeed Powell as Fed chair - including Waller, Kevin Hassett (Director of the National Economic Council), and Kevin Warsh (former Fed governor) - would likely advocate for faster and deeper rate cuts. Assuming sufficient consensus, the FOMC could potentially lower rates by 100 to 150 basis points (bps) from the current range of 4.25%- 4.5%.

However, this would not represent a radical departure from current policy; it's at the lower end of current Fed estimates for the neutral rate. Thus, by cutting rates at a steady pace, the Fed under Powell could potentially reach neutral before a new chair is appointed.

Much hinges on the Fed's estimate of neutral - and whether a Trump-nominated chair would argue for a level below the current central tendency range of 2.6 to 3.6%. While supply-side expansion could help limit inflationary pressures, higher supply-side growth is typically associated with elevated investment, which tends to raise the neutral rate. If such growth materializes, it would be difficult to justify a policy rate significantly below the Fed's estimated neutral range.

In our view, the case for a much lower neutral rate appears inconsistent with the Trump administration's optimistic growth projections. Both Hassett and Warsh have said that Trump's tax and tariff policies could lift U.S. real GDP growth to around 3%.

Moreover, even if a Trump nominee pushes for a much faster return to neutral, the Fed, as always, makes policy decisions by committee. It would take more than one or two votes to sway policy dramatically away from a steady, measured return to neutral.

Why Fed Chair Powell will likely serve his full term
Despite persistent rumors and occasional threats from the president, we still believe it is highly unlikely that Trump will move to fire Powell before his term ends in May 2026. There are compelling legal, political, and practical reasons for this view.

• Legal constraints: The most significant barrier to removing Powell is legal. Earlier this year, the Supreme Court affirmed the Federal Reserve's special status as a quasi-private institution, whose governors can only be removed for "cause" - a high threshold typically reserved for serious misconduct such as fraud. While some Republican lawmakers have tried to build a case for removal by pointing to cost overruns in the Fed's building renovations, the Federal Reserve Board has quickly responded with reasonable rebuttals. Powell has also called for an independent Inspector General review and privately indicated that he would challenge any attempt to unseat him - likely remaining in his position while the matter is litigated.
• Political realities: Even if Trump could legally remove Powell, doing so would be politically risky and likely counterproductive. All Fed nominees require Senate confirmation, starting with the Senate Banking Committee. Given the current political landscape, it could be difficult for Trump to secure unanimous support from Republican committee members, especially if the move is perceived as an attack on the Fed's independence. In the committee, a single Republican vote in opposition could derail a nomination. Two GOP members of the Senate Banking Committee, Thom Tillis and John Kennedy, have said that firing Chair Powell should be avoided, with Tillis saying it would "undermine the credibility of the U.S.". Like his predecessors, Trump - in his first administration - struggled to advance controversial Fed nominees, with several high-profile withdrawals and failed confirmations in recent years.
• Economic and market consequences: Firing Powell could carry significant market risks. Past speculation about his potential removal has led to higher long-term interest rates and declines in equity markets - outcomes contrary to the administration's goals. Leading economists and former Fed officials have warned that such a move could undermine confidence in the central bank, raise inflation expectations, and call into question the unique global status of U.S. capital markets. The likely consequences: steeper yield curves, higher rates, and a weaker dollar.
• Institutional checks: Finally, as noted above, it is important to remember that the Fed chair holds only one of 12 votes on the policy-setting FOMC. Even if Trump were to install a politically partisan chair, it is far from certain that the rest of the committee would support a dramatic shift in policy. It's worth noting that of the current seven-member Fed Board of Governors - all of whom vote in the FOMC - only two were nominated during Trump's first term, while the others were nominated by President Joe Biden.

Bottom line
Over the next few years, barring an unexpected negative economic shock or more concerning underlying inflationary pressures, we expect a steady return to a neutral monetary policy stance - first under Powell's leadership through May, and then under the next Fed chair. Fed independence, combined with economic fundamentals and institutional checks, supports this baseline outlook.

In the near term, while Trump is likely to continue criticizing the Fed and advocating for lower rates, we do not expect him to attempt to fire Powell. Instead, Trump will begin shaping the Fed through upcoming appointments, beginning with the expiration of Governor Adriana Kugler's term in January and Powell's chairmanship in May (Powell's term as governor, distinct from his role as chair, runs through January 2028).

Whoever Trump chooses as next chair will, like any Fed leader, have to present a credible case for monetary policy decisions that garners Senate confirmation first and then a majority FOMC support. As with other institutions of the U.S. governing system, the Fed is structured with built-in checks and balances that limit the ability of any single individual to dramatically shift its policy trajectory.

Catch up on recent editions of Macro Signposts:

• The Economic Impact of U.S. Tariffs: Waiting, Watching, and Planning | 16 July 2025
• Developed Market Public Debt: A Long Road Ahead | 24 June 2025
• U.S. Policy Watch: From Trade to Taxes | 18 June 2025
• PIMCO Secular Outlook Key Takeaways: The Fragmentation Era | 10 June 2025
• Japan: Rates and Risks Back on the Global Stage | 3 June 2025

Not yet subscribed? To receive Macro Signposts each week, please sign up here. Macro Signposts highlights weekly takeaways from the data analysis conducted by our team of economists and other macro experts. For PIMCO's official views on the global economy, please visit pimco.com.

We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].

For regular insights on U.S. policy via email, please sign up here to receive PIMCO Washington Watch from Libby Cantrill, head of public policy.

All investments contain risk and may lose value.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. Since PIMCO Europe Ltd services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorized and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). PIMCO Europe GmbH Italian Branch (Company No. 10005170963, Via Turati nn. 25/27 (angolo via Cavalieri n. 4) 20121 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain), PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50-52 Boulevard Haussmann, 75009 Paris, France) and PIMCO Europe GmbH (DIFC Branch) (Company No. 9613, Unit GD-GB-00-15-BC-05-0, Level 15, Gate Building, Dubai International Financial Centre, United Arab Emirates) are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively, (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF and (6) DIFC Branch: Regulated by the Dubai Financial Services Authority ("DFSA") (Level 13, West Wing, The Gate, DIFC) in accordance with Art. 48 of the Regulatory Law 2004. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. According to Art. 56 of Regulation (EU) 565/2017, an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO Europe GMBH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). According to the Swiss Collective Investment Schemes Act of 23 June 2006 ("CISA"), an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO (Schweiz) GmbH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (112) Jin Guan Tou Gu Xin Zi No. 015. The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | Note to Readers in Colombia: This document is provided through the representative office of Pacific Investment Management Company LLC located at Carrera 7 No. 71-52 TB Piso 9, Bogota D.C. (Promoción y oferta de los negocios y servicios del mercado de valores por parte de Pacific Investment Management Company LLC, representada en Colombia.). Note to Readers in Brazil: PIMCO Latin America Administradora de Carteiras Ltda.Av. Brg. Faria Lima, 3477 Itaim Bibi, São Paulo - SP 04538-132 Brazil. Note to Readers in Argentina: This document may be provided through the representative office of PIMCO Global Advisors LLC AVENIDA CORRIENTES, 299, Buenos Aires, Argentina. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2025, PIMCO.

CMR2025-0722-4686339