Yes, it is possible for the Federal Reserve to implement more interest rate cuts than currently indicated in the Summary of Economic Projections (SEP). However, this would likely require a clear indication of an impending recession. Sequential readings of core PCE close to target can trigger 1 (or 2) additional rate cuts relative to the SEP.
In this note, we employ the FRB-US model to simulate the Federal Reserve’s policy response under scenarios involving either downside surprises in inflation or upside surprises in the unemployment rate. The model’s overarching conclusion is unambiguous: small deviations from current expectations have minimal impact on the policy outlook.
From a practical standpoint, the model suggests the following:
A Monthly increase in core PCE inflation of approximately 0.3% to 0.4% over the coming months would likely eliminate the possibility of accelerated rate cuts.
Minor increases in the unemployment rate (on the order of 0.1 percentage points) are insufficient to prompt additional easing—particularly if core inflation remains elevated.
Conversely, the model implies that the Federal Reserve would be inclined to cut rates more aggressively than projected in the latest SEP if core inflation consistently prints near target for one quarter (1 to 2 additional cuts relative to the SEP), or if economic conditions deteriorate to the extent that they suggest the onset of a recession (several more cuts relative to the SEP).
Based on our discretionary assessment, we assign the following subjective probabilities to the likelihood of a policy rate cut at upcoming FOMC meetings: for July, the probability is close to 0%, barring a significantly adverse labor market report; for September, we estimate a 50% probability; and for December, the probability exceeds 90%.
Updated Baseline
We have updated our baseline scenario to incorporate the latest data releases and revised assumptions. This iteration reflects updated figures for first-quarter GDP, a revised trajectory for core import prices, new projections for long-term interest rates, as well as updated estimates for the unemployment rate and core PCE inflation in the second quarter. As in previous editions, the model forecasts are represented by red dashed lines, while the blue dots correspond to the latest projections from the Summary of Economic Projections (SEP). The financial variable trajectories consistent with the updated model baseline are available here.
Overall, this new run is only marginally weaker than the previous. The model continues to expect 2 cuts in 2025, as in the latest SEP.
Note: Real GDP growth and core inflation are expressed on a year-over-year basis. Core inflation refers to core PCE price inflation. The red-dashed lines are the model baseline forecast, while the blue dots are the latest SEP. This forecast has been updated as outlined in the text.
Scenario#1: Lower than Expected Inflation
In this scenario, we simulate an exogenous decline in core PCE price inflation relative to current expectations. Specifically, we construct three distinct scenarios in which inflation, from this point forward, follows an annualized rate of 2.5% (purple line), 2.25% (green line), and 2.0% (gray line), respectively. As illustrated in the figure below, if inflation were to surprise to the downside, the model suggests that the Federal Reserve could implement one or two additional rate cuts in 2025. Having said that, in the model sequential readings of core PCE close to 2% do not generate more than 1-2 additional cuts relative to the baseline.
Note: Real GDP growth and core inflation are expressed on a year-over-year basis. Core inflation refers to core PCE price inflation. The red-dashed lines are the model baseline forecast.
Scenario#2: Higher than Expected Urate
In this scenario, we simulate an upside surprise in the unemployment rate, while holding real GDP growth constant. As in Scenario 1, we consider three trajectories: an increase in the unemployment rate to 5.5% with persistence at that level (purple line), a rise to 5.0% (green line), and a continuation at the current rate (gray line).
It is important to emphasize that this scenario is intended solely for illustrative purposes. The model’s Taylor rule specification responds to the output gap rather than the unemployment rate per se (for a more realistic dynamic, see Scenario 3). As a result, while the model suggests that the Federal Reserve would respond with a somewhat faster pace of rate cuts relative to the baseline, the magnitude of the adjustment remains modest.
Note: Real GDP growth and core inflation are expressed on a year-over-year basis. Core inflation refers to core PCE price inflation. The red-dashed lines are the model baseline forecast.
Scenario#3: Mild recession with perfect foresight
A more realistic approach to simulating an increase in the unemployment rate and its macroeconomic implications is to assume the onset of a mild recession. In this scenario, we posit the following assumptions: (i) real GDP growth will be significantly weaker than previously anticipated—specifically, hovering around 0% on a year-over-year basis in 2025; (ii) the Federal Reserve possesses perfect foresight; and (iii) the Fed’s policy response follows a non-inertial Taylor rule.
Under these conditions, the unemployment rate rises to a peak of 5%, and the Federal Reserve responds with a notably aggressive pace of rate cuts throughout 2025.
(For reference: as always, we are able to simulate alternative scenarios upon request, including a mild recession under perfect foresight combined with an inertial Taylor rule.)
Note: Real GDP growth and core inflation are expressed on a year-over-year basis. Core inflation refers to core PCE price inflation. The red-dashed lines are the model baseline forecast.