US Inflation Seen at 3.5% as Markets Price in Fed Rate Cuts

US Interest Rates Expected to Decline as Inflation Seen Stabilizing Around 3.5%

Investors and economists are increasingly expecting a significant drop in US interest rates, as inflation expectations for the year ahead settle around 3.5%, according to market-based forecasts.

Rate Cuts on the Horizon

The market is now pricing in over 100 basis points in rate reductions from the Federal Reserve in the next 12 months. This outlook is largely driven by confidence that the inflation shock resulting from new US tariffs will be short-lived or mild—despite initial market fears.

“Expectations have moved sideways since April, but inflation forecasts are extending out—indicating that markets expect inflation to cool gradually,” analysts at Tredu report.

Fed’s Policy Dilemma: Transitory or Sticky Inflation?

Some analysts warn against assuming inflation shocks will be transitory, referencing central banks' past underestimation during the COVID-19 pandemic. However, recent survey-based inflation expectations and contained CPI data support the current dovish outlook.

“The US dollar has strengthened notably due to the Fed’s credibility as a prudent central bank,” one market strategist noted. “Still, the inflation picture is complex, especially under politically driven policies like those proposed by President Donald Trump.”

Inflation vs. Tariffs: Balancing Act

Concerns about new inflationary pressures from tariffs—especially on EU and Japanese goods—have somewhat subsided. Investors now believe that the shock, if any, will not require sustained tightening and might instead allow the Fed to begin easing as early as Q4 2025.