Goldman Sachs revamps Fed interest rate cut forecast for 2025

The Fed is under fire for its monetary policy decisions this year.

Last year, it decided the risks of rising unemployment were greater than the risk of sticky inflation. As a result, it cut interest rates last September, November, and December, shaving a total of 1% off the Fed Funds Rate used by banks to set lending rates on everything from credit cards to mortgage rates.

The pivot from rate hikes in 2022 and 2023 to rate cuts was widely forecast, and a big reason behind the S&P 500's epic 24% return in 2024. Most thought the Fed would continue to put its foot on the economic gas pedal, reducing rates in 2025, too.

However, that hasn't happened. The Fed has left interest rates unchanged despite rising layoffs and declining GDP growth.

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What caused the Fed to pause? Tariffs.

After the Fed's most recent meeting, where they left rates again unchanged within the 4.25% to 4.5% range, Fed Chairman Powell conceded that uncertainty surrounding the inflationary impact of tariffs had forced it to the sidelines.

That decision has drawn sharp criticism from President Trump's administration, who view interest rate cuts as key to propping up the economy and offsetting the drag tariffs may cause.

Nevertheless, Wall Street expects that the Fed won't remain sidelined forever. Goldman Sachs, one of the most influential firms, has updated its interest rate cut outlook for 2025 based on the most recent economic data.

An economy at risk has backed the Fed into a corner

The Fed has two jobs: low inflation and unemployment.

Unfortunately, accomplishing its mission isn't easy. Increasing interest rates slows inflation but raises unemployment, while cutting rates increases inflation but lowers unemployment.

The contrary nature of its dual mandate is on full display this year. The Fed's rate hikes in 2022 and 2023 drove inflation from 8% to below 3%. However, they also caused the unemployment rate to increase to 4.1% from 3.4% in 2023.

The Fed's cuts last year were designed to strike a balance, propping up the jobs market without fanning inflationary fires.

Unfortunately, President Trump's tariffs, including 25% on Canada, Mexico, and autos, plus 30% on China and a baseline 10% tariff on all imports, make it much harder for the Fed to walk the inflationary tightrope.

If the Fed cuts more, inflation may reassert itself. If it stays put, the economy may sour and slide into stagflation or recession.

There's already evidence that the economy is weakening. GDP shrank 0.5% in Q1, and the Fed and World Bank expect GDP to be just 1.4% in 2025, down from 2.8% in 2024.

Goldman Sachs ups its rate cut outlook for 2025

The particularly tough backdrop is that some Wall Street firms, including Bank of America and Morgan Stanley, expect the Fed to remain sidelined for the rest of this year.

Goldman Sachs doesn't share that opinion. It expects that the Fed will turn friendly again, embracing dovish cuts this fall.

Their economists previously expected the Fed to reduce its Fed Funds Rate twice before year's end. However, they changed that outlook recently, and now expect the Fed to cut rates three times.

They altered their outlook based on lower-than-expected impacts from tariffs on inflation so far, plus ongoing question marks in the jobs market.

For perspective, while the unemployment rate fell to 4.1% in June from 4.2% in May, a better-than-expected outcome, companies have laid off over 696,000 workers this year through May, up 80% year over year, according to Challenger, Gray & Christmas.

Goldman Sachs expects the first quarter-point rate cut to occur in September. The Fed is expected to cut again by the same amount at the FOMC's October and December meetings.

In 2026, it predicts an additional two rate cuts, which would leave the Fed Funds Rate at 3% to 3.25%.