March 19, 2025

QuickTakes

Certainly Uncertain

Federal Reserve Chair Jerome Powell used the word "uncertainty" 16 times in his press conference today. We sympathize. At the outset, it's impossible to know what tariffs will be imposed by the US on April 2., on which countries, and for how long. When the specifics are revealed, it will still be difficult to forecast their impact on economic growth and inflation in the US and around the world. Another known unknown is the response of America's trading partners to reciprocal tariffs. Will they lead to negotiated reciprocal reductions in tariffs or to escalating retaliatory tariffs?

No wonder that the FOMC unanimously decided to leave the federal funds rate (FFR) unchanged at 4.25%-4.50%. Committee officials did revise their economic forecasts, however. They lowered their economic growth projections and raised their near-term unemployment and inflation expectations. The median projection of FOMC members was still two 25bps rate cuts this year, just as the futures market projects (chart). That's probably because tariffs are expected to lead to a one-time price increase while they (along with limited immigration) weigh on the growth outlook.

In his presser today, Powell repeatedly said that the Fed was in no hurry to lower rates. To us, the operative word is "lower," suggesting that monetary policy continues to have a dovish bent. While we remain in the none-and-done camp for the rest of the year, we acknowledge that the FFR would be lowered readily if the unemployment rate started to increase quickly. The FOMC's median projection is that the unemployment rate will finish the year at 4.4%, up from 4.3% in last December's projection (chart).

After the FOMC's Summary of Economic Projections was released this afternoon, the 2-year and 10-year US Treasury note yields edged down to 3.993% and 4.237%. Stock prices also received a slight boost. Investors are glad to know that the Fed Put remains on standby if needed to support the economy.

So far, initial unemployment claims through the March 7 week suggest that the unemployment rate remained low in March. But federal government job cuts could boost it in coming months.

The FOMC also lowered its real GDP projections. This year's forecast was revised down from 2.1% to 1.7%, next year's from 2.0% to 1.8%, and 2027's from 1.9% to 1.8% (chart). Nearly all FOMC participants agreed that the unemployment rate and GDP growth will probably get worse. Then again, Fed officials have been too negative on growth for the past couple of years. While 1.5%-2.0% real GDP growth is possible for the first half of the year, we think it will recover to 2.5%-3.0% by Q4 as productivity growth picks up. We continue to bet on the resilience of the economy, as we have for the past three years.

A real possibility is that the Fed might not be willing to cut interest rates at all if inflation expectations become unanchored. Consumers' inflation expectations have been rising recently, and the Atlanta Fed's measure of business inflation expectations rose from 2.0% in December to 2.5% today. Import price inflation, which doesn't include tariffs, also increased in February.

The bond market is signaling that inflation from tariffs is likely to be transitory. We agree because unit labor costs inflation, which is the underlying source of inflation in a services economy like ours, should remain contained around 2.0% if productivity growth remains strong, as we expect (chart).

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