The Federal Reserve held its key rate, the fed funds rate, at 4.25 – 4.50% as expected. But Fed officials downgraded the economic outlook for 2025 and raised its forecast for inflation (again) in its quarterly Summary of Economic Projections.
Why was the forecast for GDP, the largest measure of economic growth, revised to 1.7% for 2025 from 2.1% issued three months ago?
First, let’s take the actual numbers with a grain of salt (or two). Economic forecasting is an imprecise science, as Fed Chief Powell acknowledged. However, in this case, the direction is what counts, and that direction is lower.
The Fed is confronting major uncertainties, particularly with trade policy. Additionally, issues like immigration, federal spending, and possible tax cuts are also on the horizon. In other words, visibility is limited.
Transitory unretired
The word ‘tariff(s)’ was mentioned 47 times during the 49-minute press conference.
The Fed believes that new taxes being enacted on imports and the possibility that more tariffs will be levied will raise prices at home. For now, however, the Fed expects this to be a one-time boost.
“It can be appropriate sometimes to look through inflation if it’s going to go away quickly without action by us, if it’s transitory. And that can be the case of tariff inflation,” Powell said.
‘Transitory’ is a word that makes economists and investors a little queasy because it was used to describe what was expected for inflation in 2021.
As the economy reopened, prices jumped. But the surge in inflation was expected to be transitory (temporary), according to Fed officials, until, well… it wasn’t.
Though he acknowledged there is uncertainty, Powell pivoted back to transitory, and it raised eyebrows considering what happened in 2021.
Powell offered an interesting example of tariffs levied on washing machines in 2018 and the uncertainties involved:
“Washing machines were tariffed in the last round of tariffs, and prices went up. But prices also went up on dryers which were not tariffed. So, the manufacturers just followed the crowd and raised (prices) it (on dryers).”
Why might he be right? It’s a one-time tax increase on imported goods.
Why might he be wrong? There isn’t a modern precedent for modeling broad-based tariffs. Secondary effects, such as ‘echo’ price hikes or indirect increases, cannot be ruled out.
Despite the unsettling economic outlook, investors found some reassurance in the Fed’s interest rate projections.
Although the Fed raised its inflation forecast, there was no discussion of rates, only the possibility of keeping rates steady or lowering them if economic conditions warrant.