Fed may reverse 2025 rate cuts as jobs data shifts policy outlook

The Fed's 2025 insurance cuts face reversal as a resilient labor market pushes rate-hike odds to 98 percent.

The Federal Reserve may reverse the series of insurance rate cuts it delivered in 2025, tightening policy as a strong labor market and elevated crude oil keep inflation above target, RBC Wealth Management said.

"The market is now pricing in a complete reversal of the 2025 easing cycle, and the data supports that repricing," RBC Wealth Management said in a note. "The labor market has not cracked the way rate-cut proponents expected."

The May nonfarm payrolls report showed the economy added 172,000 jobs, more than double the 85,000 consensus estimate, while the unemployment rate held at 4.3 percent for a third straight month. The 10-year U.S. Treasury yield jumped above 4.5 percent and the 30-year yield pushed past 5 percent, while the U.S. Dollar Index rose to its strongest level since early April. Money markets now price a 98 percent probability of a rate hike at the Fed's next meeting later this month, according to CME FedWatch data.

If the Fed follows through and reverses its 2025 cuts, it would tighten financial conditions at a time when borrowing costs are already elevated, potentially slowing economic growth and triggering a broad sell-off in equities and rate-sensitive assets. The alternative — holding steady — risks allowing inflation to reaccelerate, particularly with West Texas Intermediate crude oil holding near $90 a barrel and Brent crude above $95.

The repricing has been abrupt. As recently as April, markets were pricing multiple rate cuts for the second half of 2026, betting the economy would cool enough to give the Fed room to ease. The May payrolls number shattered that narrative. April's figure was also revised higher to 179,000, confirming that the labor market's resilience was not a one-month anomaly. Wage growth held firm, giving the committee no signal that the jobs market is softening.

Cleveland Federal Reserve President Beth Hammack said this week that rate hikes are still possible, pointing directly to energy costs as a key concern. "Strong jobs data plus elevated crude oil gives the committee no room to ease," she said, according to prepared remarks. Her comments align with the hawkish tone emerging from multiple Fed officials ahead of the July meeting.

Rate Hike Odds Surge to 98%

CME FedWatch data shows rate hike probabilities surging from below 10 percent in early May to 98 percent today. The last time the market priced a comparable probability of tightening was in mid-2023, when the Fed was in the final stages of its previous hiking cycle. That cycle ended with the fed funds rate at 5.25 percent to 5.5 percent, where it remained until the 2025 insurance cuts began.

The 2025 cuts were designed to preempt a feared economic slowdown that never materialized. Instead, wage growth has held firm and consumer spending has remained strong. The question now is whether the Fed will admit the cuts were premature and reverse them, or hold the current rate and wait for clearer signs of a slowdown before acting.

Cross-Asset Fallout

The implications extend beyond short-term rates. Higher yields make Treasuries more attractive relative to equities, particularly growth stocks sensitive to discount rate changes. The dollar's strength adds pressure on emerging markets and commodity prices. Spot gold sold off sharply after the payrolls report, and spot silver dropped 8.31 percent in a single session as institutional investors repositioned across multiple asset classes simultaneously.

For borrowers, a rate reversal would mean higher mortgage rates, higher corporate borrowing costs, and tighter financial conditions across the board. The housing market, already showing signs of strain under elevated rates, would face additional pressure.

The Fed's next policy meeting is later this month, with Chair Kevin Warsh presiding. The decision will hinge on whether the committee views the recent data as a temporary bump or a fundamental shift in the economic trajectory that requires policy action. RBC Wealth Management's analysis suggests the latter — and markets are already pricing it in.

This article is for informational purposes only and does not constitute investment advice.