Fed remains on pause amidst uncertainty but ratchets down balance sheet runoff

Executive summary

As widely expected, the Federal Reserve (Fed) left its target federal funds rate unchanged for a second straight meeting. However, it announced a downshift in the pace of their balance sheet runoff beginning in April.

The updated economic projections – the so-called ‘dot plot’ – still foresees two rate cuts in 2025 but lowered the growth outlook and increased their views on inflation and the unemployment rate compared to the December projections.

During the press conference, Fed Chair Powell stressed the uncertainty in policy changes by the new administration as well as how the economy would respond to potential shifts, especially because of tariffs. He also made it clear that the Fed isn’t in a hurry to change.

The initial market reaction was straightforward with stocks cheering as bond yields fell.

We reiterate our view that the Fed will stay in ‘wait & see’ mode for a while longer, while other major central banks, such as Canada, the United Kingdom, and the European Central Bank, are continuing to cut their benchmark rates.

What happened

At its March rate-setting meeting, the Federal Open Market Committee (FOMC) maintained its target range for the federal funds rate at 4.25% – 4.50%. That’s unchanged from January.

It announced that, beginning in April, the pace of its balance sheet runoff (i.e., quantitative tightening, or QT) would be lowered as the monthly redemption cap on U.S. Treasury securities would decrease from $25 billion to $5 billion; however, the cap on agency mortgage‑backed securities (MBS) stays at $35 billion.

Additionally, the FOMC released its March statement of economic projections, which sees the same number of rate cuts this year (two) compared to the December projections, but slower economic growth with higher inflation and unemployment rate.

In his prepared remarks at the outset of the post-meeting press conference, Chair Powell repeatedly stated that there was a high degree of uncertainty due to policy changes by the new administration. He also reiterated that the committee was "not in a hurry to lower rates" in the near term, which he frequently noted during the question & answer portion of the press conference.

Reporters pressed Chair Powell hard about potential tariff impacts, he rebutted most by leaning heavily on uncertainty in both directions, suggesting that some might not be permanent. He also highlighted the chasm between hard data – such as figures for jobs, retail sales, factory orders, production, and other measures of output that remain strong – as opposed to soft data, such as sentiment surveys, which are telling a very different story.

Our take

The Fed remains on hold, which makes sense given the tremendous amount of uncertainty for policy shifts by the new administration for tariffs, immigration, fiscal levers, and regulations. 

Indeed, uncertainty casts a long shadow over the economy, clouding decision-making for businesses, consumers, and policymakers alike. Accordingly, many businesses are also taking a ‘wait & see’ approach, which seems prudent but isn’t pro-growth either for the economy or for business profits. At the very least, it causes some businesses to delay actions that they would have taken, while others may eventually choose to cancel plans all together due to the uncertainty. Some consumers appear to be doing the same. Furthermore, the longer this uncertainty persists, it intensifies the drag on the economy.

Yet, we believe that if economic data decelerates, the Fed will reduce interest rates sooner than is widely expected, which should help boost economic growth. If consumer demand weakens, it’s possible that some of the potential inflationary pressures from tariffs wouldn’t materialize. Moreover, with the Fed’s target rate at 4.25% to 4.50%, there’s ample room to cut rates if needed.

In the meantime, the downshift in the pace of their balance sheet runoff is meaningful and should contribute to lowering U.S. Treasury yields, all else being equal.

But the Fed can’t front-run potential policies implemented by the new Trump administration, such as tariffs, or stepped-up immigration enforcement further tightening labor markets, etc. Unfortunately, the Fed needs to wait for those policies to be enacted as the details dramatically alter the impacts on the economy. For instance, targeted incremental tariffs on a limited number of goods from one or a few countries (such as China) would have a modest economic impact compared to larger universal tariffs covering most incoming imports.

Additionally, it’s important to note that other major central banks continued to cut their benchmark interest rates, including Canada, the United Kingdom, and the European Central Bank. This adds to the growing interest rate differential between U.S. Treasuries and their equivalents in other developed markets.

Higher U.S. rates (a.k.a., rate differentials), along with higher economic growth comparatively, had contributed to a stronger U.S. dollar since the November election but that strength has effectively disappeared in the past three weeks.

Equity market reaction

U.S. stocks, which were modestly positive ahead of the meeting statement release at 2PM, began to climb further upon its released. Once Chair Powell started his press conference, stocks moved higher as the S&P 500 Index rose nearly 1%, though pared those gains near the end of the trading session.

Bond market reaction

Thus far in 2025, U.S. Treasury yields have trended lower albeit against a volatile backdrop. In early January, yields rose sharply only to erase that move and decline even further based on economic growth concerns and the uncertain scope and impact of U.S. tariff policy. After touching 4.15%, the 10-year U.S. Treasury yield has discovered some stabilization around 4.25-4.30%, seemingly awaiting more clarity on the Fed’s path forward and where trade policy ultimately lands.

Over the past week, U.S. Treasury yields largely chopped sideways but rose slightly before the official FOMC decision. However, yields quickly dropped once the Fed revealed that it would slow the pace of its quantitative tightening program on April 1st.  With this change, the Fed will reinvest a greater share of maturing U.S. Treasury securities back into the new issue market. This decision should relieve some of the pressure on other U.S. Treasury market participants to absorb new U.S. debt supply moving forward. While we expected the Fed would slow its QT program this year, the timing of this shift is somewhat earlier than the consensus forecast. However, the slower reduction to the Fed’s balance sheet should help alleviate liquidity pressures preemptively that may arise around the debt ceiling debate in D.C.

U.S. interest rates will remain very sensitive to fiscal policy developments and incoming economic data. Concerns around the potential impact of tariffs and their potential economic impact may create tactical opportunities to shift portfolio duration; however, these unknowns still support a neutral portfolio duration. Given our expectation that inflation will continue its bumpy cooling process, we still expect the Fed to gradually lower the federal funds rate by 50 basis points (0.5%) by the end of 2025.

Bottom line

The Fed remains in ‘wait & see’ mode, holding rates steady, which will endure for a while longer in our opinion. That said, the downshift in the pace of their balance sheet runoff beginning in April is meaningful and should contribute to lowering U.S. Treasury yields. Despite modestly slower growth and elevated policy uncertainty, we believe in the resilience of the U.S. economy, though we expect that the Fed will get a chance to lower rates later this year.