No Cuts Coming: Jonny Matthews Explains the Fed’s 2025 Stand and Economic Outlook

Former Brevan Howard portfolio manager argues that core inflation above 3% for three years and sticky services inflation will prevent Fed easing cycle continuation in 2025.

Key Takeaways

• The Federal Reserve will likely stay on hold for the first half of 2025, contrary to market expectations for continued rate cuts
• Core inflation has remained above 3% for three and a half years, with services inflation showing persistent stickiness
• US economy enters 2025 with exceptional strength: healthy labor market, record household wealth, and strong corporate earnings growth
• Tariff implementation could create upward pressure on goods prices, forcing Fed to look beyond "transitory" price adjustments
• Ten-year Treasury yields could reach 5% as markets adjust to higher neutral rate environment
• Dollar strength will be selective rather than broad-based, with particular weakness expected in Sterling due to UK fiscal policies

Timeline Overview

• Career Foundation — Matthews transitions from aerospace engineering to Salomon Brothers in 1993, learning market-making in derivatives
• Financial Crisis Preparation — Recognizes housing bubble signs in 2006-2007, positions for volatility with variant swaps and downside protection
• Crisis Profitability — 2008 financial crisis validates thesis as protection products pay off handsomely during market collapse
• Macro Focus Evolution — Post-2008 shift from relative value trading to macro strategy, emphasizing fundamental economic analysis
• Current Outlook Formation — Recent years developing "higher for longer" thesis based on inflation persistence and structural changes

Trading Career Evolution and Market Lessons

Matthews' journey from British Aerospace engineer to macro trading veteran illustrates how market structure fundamentally shapes trading opportunities. His engineering background at Imperial College provided analytical foundations, though initial career uncertainty led him through aerospace before discovering finance.

• Salomon Brothers experience in 1990s taught aggressive market-making in derivatives when bid-offer spreads generated substantial margins due to limited competition
• Early success came from customer flow business in options and complex derivatives, creating perception of trading genius while actually benefiting from structural advantages
• Transition to Brevan Howard as portfolio manager in 2004 provided harsh reality check about pure proprietary trading without customer flow safety net
• Financial crisis preparation began in 2006-2007 when housing market leverage became obviously unsustainable with waiters buying multiple properties
• Variant swaps on Euro Stoxx quoted at 18 to 18.1 implied volatility represented "zero margin" pricing that enabled massive position accumulation
• Crisis profitability came from correctly anticipating systemic breakdown, though early exit before Lehman collapse limited maximum gains

The evolution from flow-dependent trading to pure macro strategy required developing deeper economic understanding. Matthews emphasizes that writing daily research for four years significantly sharpened trading decisions by forcing articulation of market views.

"I thought I was this genius prop trader making all the money for City Group," Matthews recalls of his early overconfidence, highlighting how market structure can mask true skill levels.

US Economic Foundation and Fed Policy Outlook

The US economy enters 2025 from a position of remarkable strength across multiple metrics, contradicting typical recession indicators. This foundation supports Matthews' view that Federal Reserve policy will remain restrictive longer than markets anticipate.

• Household income continues growing at healthy pace while more jobs remain available than unemployed workers seeking employment
• Corporate and household debt servicing costs represent lowest percentages in decades due to previous deleveraging and term extensions
• Average outstanding mortgage rate of 4% creates lock-in effect as new mortgages require 7% rates, reducing household mobility
• Household wealth reached record $160 trillion in Q3 2024, with continued gains from equity market appreciation
• Q4 GDP growth appeared weak at headline level but consumption remained extremely strong with inventory drawdown masking underlying momentum
• Corporate earnings for S&P 500 companies track toward 12-13% growth rate, eliminating incentive for labor shedding

Federal Reserve policy framework faces fundamental challenge from persistent inflation that refuses to return to pre-pandemic patterns. Matthews argues that three-year persistence above 3% represents structural shift rather than cyclical deviation.

The policy dilemma intensifies as markets price 85 basis points of additional cutting before year-end, implying deposit rates below 2% and negative real rates. This expectation appears disconnected from economic fundamentals and inflation reality.

Inflation Persistence and Labor Market Dynamics

Core inflation's stubborn persistence above 3% for three and a half years signals fundamental shift from pre-pandemic disinflationary environment. Service sector inflation remains particularly problematic for Fed officials seeking sustainable price stability.

• Services inflation shows minimal decline compared to goods and energy sectors that previously dragged headline inflation lower
• Rental inflation measured by CPI at 5% versus real-time measures like Zillow showing 3-3.5%, suggesting convergence toward higher sustained levels
• House prices at record highs support rental yield expansion as affordability constraints force more households into rental market
• Food inflation remains stable component while energy and goods deflationary pressures fade rapidly
• Labor market cooling evident in quits rate dropping to 2% for consecutive months, reducing typical wage pressure mechanism
• Average hourly earnings growth running at 4% with expectation for modest deceleration rather than collapse

Recent job openings data shows weakness, yet corporate earnings growth of 12-13% eliminates motivation for significant labor force reductions. Immigration policy tightening will likely create additional labor market tightness.

The key insight involves recognizing that inflation environment has shifted structurally higher. Markets remain anchored to pre-pandemic expectations of 1-2% inflation and ultra-low rates, creating disconnect with emerging reality.

"We're now in an environment where inflation is 3 to 4% maybe, the neutral rate is higher," Matthews observes, challenging prevailing market assumptions about sustainable price levels.

Tariff Strategy and Economic Implications

Trump administration tariff approach combines negotiation tactics with revenue generation, creating complex economic implications beyond simple trade protection. Matthews analyzes both immediate tactical use and broader strategic objectives.

• 25% tariffs on Mexico and Canada postponed for one month following border security negotiations, suggesting tactical rather than purely economic motivation
• 10% additional tariffs on China represent incremental pressure on existing trade restrictions rather than fundamental policy shift
• Auto sector faces particularly severe disruption as transmission and engine components cross borders seven to eight times during production
• Currency adjustment already providing partial offset as Chinese yuan weakened 3% since Trump election, reducing effective tariff impact
• Supply chain reconfiguration costs will create upward price pressure even without full tariff implementation

Tariff revenue potential of $300 billion from full implementation would provide meaningful offset to planned tax cut extensions. However, economic disruption costs likely exceed revenue benefits across most sectors.

Federal Reserve faces policy complexity in responding to tariff-induced price increases. While economic theory suggests looking through one-time price level adjustments, recent "transitory" inflation experience creates institutional hesitancy about dismissing price pressures.

The broader question involves whether tariffs represent negotiation strategy or genuine belief in manufacturing reshoring benefits. Matthews notes that basic economic knowledge suggests mutual trade benefits make aggressive protectionism counterproductive.

Global Market Dynamics and Currency Outlook

Dollar strength will require more selectivity rather than broad-based appreciation across all currency pairs. European and Asian economic developments create differentiated opportunities despite general dollar bullishness.

• European Q4 GDP weakness concentrated in export sector while consumption growth remained healthy, suggesting underlying resilience
• German manufacturing challenges stem from Russian energy loss and nuclear reactor closure decisions, not fundamental competitiveness
• UK economy faces severe pressure from National Insurance payroll tax increase of 8.5% effective April plus minimum wage hikes
• Japanese 10-year bonds reach highest levels since 2011 as inflation sustains above 2% target with healthy wage growth
• Chinese real estate sector deleveraging mirrors Spain pre-financial crisis with similar balance sheet recession dynamics
• European household real income growth supports consumption expansion despite manufacturing sector difficulties

Sterling faces particular vulnerability due to UK fiscal policy mistakes. Employment data already shows consecutive monthly declines as companies prepare for April payroll tax increases. Additional price pressures from utility bill increases create stagflationary conditions.

Bank of Japan normalization cycle appears sustainable given persistent inflation above target and extremely low 2.5% unemployment rate. April wage negotiations will determine pace of further tightening.

China's structural challenges require extended resolution period similar to US post-financial crisis experience. Government debt capacity exists for stimulus, but private sector deleveraging process cannot be easily accelerated through policy intervention.

Investment Strategy and Market Positioning

Current market environment requires tactical flexibility rather than strategic positioning given elevated valuations and conflicting crosscurrents. Matthews emphasizes opportunistic downside protection purchases when implied volatility allows attractive risk-reward ratios.

• S&P 500 valuation expansion from below 17 to 22 PE ratio over past two years unlikely to repeat with earnings growth providing primary return driver
• Short-dated put spreads on US indices when implied volatility drops provide asymmetric opportunity without excessive premium cost
• Sterling downside options represent highest conviction trade given UK economic deterioration and fiscal policy errors
• European equity markets offer value characteristics with lower growth expectations creating more stable return profiles
• Long Treasury positions remain attractive toward 5% yield target as market expectations for Fed cuts prove overly optimistic
• Volatility products lack the structural mispricing available during 2006-2008 period when tail risk protection traded at negligible cost

The fundamental challenge involves recognizing that post-pandemic market structure differs significantly from pre-2020 environment. Inflation persistence, higher neutral rates, and geopolitical complexity create new paradigm for asset allocation.

Traditional portfolio construction assuming low inflation and declining rates requires adjustment. Fixed income positioning should emphasize shorter duration and higher yield capture rather than capital appreciation from rate declines.

Equity market concentration in mega-cap technology stocks creates vulnerability to multiple compression if growth expectations disappoint. Value strategies in European and emerging markets provide diversification benefits with attractive risk-adjusted return potential.

Common Questions

Q: Why won't the Fed cut rates in 2025 despite market expectations?
A: Core inflation remains above 3% for three years with persistent services inflation, while the economy shows strong momentum requiring restrictive policy continuation.

Q: How do tariffs impact Federal Reserve monetary policy decisions?
A: Tariffs create upward price pressure that Fed cannot easily dismiss as "transitory" given recent inflation experience, requiring more hawkish stance.

Q: What makes Sterling particularly vulnerable among major currencies?
A: UK payroll tax increases of 8.5% plus minimum wage hikes create employment pressure while utility price increases squeeze consumers.

Q: Why could Treasury yields reach 5% this year?
A: Market expectations for Fed cuts appear disconnected from inflation persistence and economic strength, requiring yield adjustment to attract buyers.

Q: How has AI affected productivity and economic growth expectations?
A: AI productivity benefits will take time to appear in economic data, similar to early computer revolution where improvements were visible everywhere except statistics.

Matthews' analysis suggests that Federal Reserve policy will remain more restrictive than markets anticipate throughout 2025. Economic fundamentals support higher rates while inflation persistence prevents aggressive easing despite market pressure for accommodation.

Current positioning should emphasize tactical flexibility over strategic conviction given elevated valuations and policy uncertainty across major economies worldwide.