Fed Holds Rates at 4.25–4.50%, Dollar Surges on Cautious “Wait-and-See” Stance

On May 7, 2025, the Federal Reserve hit pause on any rate changes and opted to keep its benchmark federal-funds rate at 4.25 %–4.50 %, signaling a “wait-and-see” stance amid mixed data and ongoing trade-policy uncertainty. While U.S. inflation has cooled modestly, risks from tariffs and geopolitical tensions haven’t abated, prompting policymakers to hold steady rather than making any sudden moves, such as rushing toward easing or further tightening.

Following the decision, the dollar strengthened against most major currencies, lifted by yields creeping higher and the Fed’s indication of a still-restrictive bias. However, this dollar strength put pressure on emerging-market currencies, particularly in commodity-importing nations, and briefly reversed capital flows into riskier assets.

The Fed’s Most Recent Decision in Context: Why Hold the Rates Steady?

On May 7, 2025, the Federal Open Market Committee (FOMC) announced no change to its 4.25 %–4.50 % policy rate this time around, because, as Chair Jerome Powell emphasized, economic data remain mixed. While job gains have been solid and headline inflation has drifted closer to the 2 % target, recent tariff increases threaten to push goods prices higher again. The Fed’s policy statement expressed “rising risks” from trade-policy uncertainty and underscored the need for clearer incoming data before adjusting rates.

Policymakers also seem to be stepping back from their earlier approach (the Flexible Average Inflation Targeting (FAIT) framework adopted in 2020), which allowed for a more flexible inflation target given persistent post-pandemic inflation spikes. For now, they’re playing it safe: not raising rates further, but also not cutting until the risks ease, particularly from potential retaliatory tariffs and volatile fiscal policy.

Fed Forward Guidance and Market Expectations

Following the decision, several Fed officials, including New York Fed President John Williams, have reiterated that policy is “appropriately calibrated,” though full clarity won’t arrive by summer, pushing markets to temper rate-cut bets until late 2025 or beyond.

A recent Reuters poll shows most economists now expect the first rate cut to come in July or September, but only if inflation keeps slowing and the labor market starts cooling off. Traders have pared back aggressive rate-cut wagers, instead pricing in only one or two 25-basis-point cuts by year‐end.

How is the Fed’s May 2025 Rate Decision Shaping the Dollar’s Trajectory? USD Index and Major‐Currency Moves

• Strengthened 1 % against the Japanese yen, trading near ¥143.80 after a brief dip.
• Gained 0.1 % on the Swiss franc, at SFr 0.8221, off its January 2025 low of SFr 0.8032.
• Edged up versus the euro, which suffered amid improved political stability in parts of Europe but fading ECB rate-hike bets.

FX strategists at UBS noted that the Fed’s acknowledgment of balancing inflation risks and employment objectives left markets well aware of its “two-sided” mandate dilemma, limiting a sharper dollar reaction. Nonetheless, the USD still got a short-term boost thanks to higher U.S. yields and safe-haven demand.

Capital Flows and Yield Gaps

U.S. Treasury yields remain higher than those of many other countries, making them more attractive to investors. A Reuters poll forecasts that 10-year yields could stay roughly where they are, pinned by the tug-of-war between potential recession and sticky inflation. As yields climbed, more global investors rotated back into U.S. debt, reversing some of the risk-asset flow seen earlier in May when tariff talks briefly improved market sentiment.

Spillovers to Emerging-Market Currencies

Emerging-market currencies, often more vulnerable to U.S. monetary policy shifts, took a hit after the Fed held steady. The most pronounced moves included:

• Turkish lira and Argentine peso, where local inflation is high and policy rates are well below U.S. levels, depreciated by 1–2 % in spot trading.
• South African rand and Mexican peso, more commodity-linked but still sensitive to global funding conditions, each weakened roughly 0.8 %.

Countries running current‐account deficits or with large foreign‐currency debts saw bond spreads widen, reflecting higher rollover costs as funding shifted toward U.S. markets.

Policy Responses in Emerging Markets

This led several central banks to take action to cushion their currencies and stop further damage:

• Brazil’s central bank signaled readiness to hike should the real weaken beyond a certain threshold, already up 125 bps year-to-date but still lagging behind U.S. rate moves.
• Indonesia’s BI refrained from easing despite softening inflation, citing external headwinds from the U.S. stance.
• Hungary’s MNB, facing one of Europe’s highest inflation rates, paused its rate cut cycle to prevent forint losses.

These preemptive steps are all aimed at stemming capital outflows and stabilizing key EM exchange rates.

What About Equity Flows and Risk Appetite?

Equity markets reacted unevenly: U.S. indices closed marginally higher on the Fed’s “data-dependent” message and “wait-and-see” stance, but things weren’t as rosy elsewhere. At the same time, MSCI’s Asia-Pacific index dropped 0.8%, weighed down by weak Chinese retail-sales data and lingering trade concerns. Latin American and Eastern European stocks also underperformed as local currencies slid.

Looking Ahead: When Will the Fed Pivot?

All eyes are now on the upcoming inflation prints, PCE data, and the June payrolls report to pinpoint the Fed’s first rate cut. Should CPI move back toward 2 % and wage growth slow, traders may price in a September cut. But if we see another spike in tariffs or if inflation surprises on the upside, the Fed might hold off on cutting until 2026.

Fed Chair Powell and other officials will speak publicly throughout June and July, but as Williams cautioned, “quick clarity” on appropriate policy is unlikely by then, so the dollar may stay supported in the interim. Ultimately, the balance of near-term risks ( trade policy versus disinflation), will dictate the dollar’s path and emerging-market currency resilience. Stay tuned for more updates –US First Exchange will keep you updated as the story develops.