The most consequential US macro story of 2025 is not that inflation has reaccelerated, nor that it has been tamed. It is that the price level has settled into a band — roughly 2.5 to 3 percent — that the Federal Reserve still officially treats as transitional but that firms, households, and increasingly the bond market are pricing as structural. Manufacturing output is rising, services pricing power is intact, and tariff pass-through has been real but contained. The cuts will come; the target will not.
Start with what firms actually expect. The New York Fed's regional surveys show median year-ahead inflation expectations settling at 3.0 percent, down from the 3.5 to 4.0 percent range manufacturers and service firms were carrying into 2025. That moderation is the headline. The subtext is more interesting: firms raised prices by an average of 6.0 percent in manufacturing and 5.0 percent in services this year — nearly double last year's pace in factories — and still describe the shock as one-off. Tariffs, in their telling, are a level adjustment, not a regime change. The Fed will take that anchoring as vindication. It is also a warning.
The manufacturing story is demand, not policy
The political debate over tariffs has obscured a quieter fact: US factory output is rising even as factory employment falls. Greg Ip argues in the Wall Street Journal that this is a demand story — the US happens to make things the world wants right now — rather than a tariff dividend. Noah Smith counters that PPI-adjusted shipments show continuation of decades-long stagnation, with tariffs cancelling whatever tailwinds exist. Both can be partially right. What matters for inflation is that capacity is being utilised, margins are holding, and the producer-price impulse from upstream costs is being passed through asymmetrically — hitting low-price varieties hardest, in the cheapflation pattern documented by Marginal Revolution. That is regressive inflation, and it is sticky.
The Fed will deliver the cuts the market is underpricing. It will not deliver the 2 percent the market still believes in.
The cost-side framing matters for what comes next. Simone Lenzu's work, surfaced by the New York Fed, makes the case that a Phillips curve built on real marginal costs is steep and explains inflation volatility well — the flatness everyone has been pricing is an artefact of using output gaps. If marginal costs are the right input, then services wage dynamics and tariff pass-through are doing more work on the underlying trend than the soft-landing narrative allows. Pascal Hügli's structural case — deglobalisation, tight labour, a higher new normal — lines up with the firm-level evidence even if the macro aggregates have not yet confirmed it.
Two operationalisable calls follow. First, the Fed cuts more than the curve currently prices through 2026, because growth cools and the labour market gives the FOMC permission, even with core PCE printing in the high twos. Second, the inflation undershoot the market keeps penciling in for late 2026 does not arrive: firms' own forward pricing intentions suggest median expected price increases for 2026 stay above 4 percent, which is incompatible with a clean return to target. The trade is not duration versus risk. It is breakevens versus nominals, and breakevens are too cheap.
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