• We expect the FOMC to hold rates steady at next week’s meeting, keeping the fed funds range at 4.25%-4.50%.
• The FOMC’s economic projections should begin to reflect prospects for higher, tariff-fueled inflation and softer US economic growth.
• We see policy remaining on hold through year end and rate cuts restarting in Q1 2026.
We expect the FOMC to keep monetary policy unchanged at the 18-19 March meeting and to make only modest changes to the post-meeting statement. Chair Powell will probably signal in the press conference that the committee remains in a holding pattern of indefinite duration as it seeks conviction on the economic effect of the Trump administration’s policies. Powell put it succinctly on 7 March: “The costs of being cautious are very, very low. The economy's fine. It doesn't need us to do anything, really, and so we can wait and we should wait.”
Since November, we have expected high tariffs and tight immigration policy to cause a substantial rise in inflation and a considerable slowing of economic growth. (At that time, this was a very, very out-of-consensus view.) We also foresaw two nonlinear risks: a disorderly environment could see a sharp decline in business sentiment cause a recession, and a rise in long-term inflation expectations might require the FOMC to act as it did in the early 1980s, by prioritizing inflation-fighting credibility at the expense of economic growth. Both of these risks are also now clearly growing.
The administration has moved more quickly to implement tariffs than we expected in our December outlook, by about six months. As a result, we’re bringing forward our forecasts for the trough in growth, the peak in inflation and the resumption of rate cuts by that amount of time. We now expect growth to bottom somewhat below 1% in Q3 2025; inflation to peak at close to 4% y/y in Q4 2025; and the FOMC to remain on hold through year end and to restart cutting rates in Q1 2026. We expect a fairly stable unemployment rate throughout.
Looking ahead, we tend to see three main scenarios for the economy. We put about 65% odds on the baseline outlook laid out above. We put about 25% odds on a recessionary path, with a serious downturn in business investment, a significantly weakening labor market, somewhat less inflation than in our baseline path, and an earlier return to rate cuts. We ascribe 10% odds to a scenario where tariffs cause long-term inflation expectations come under serious pressure, and the FOMC must hike rates despite a rising unemployment rate.
We think that FOMC members have been running tariff studies and will now incorporate some degree of higher inflation and lower growth as a result. According to a recent FEDS staff research note on tariff impacts, a 20pp tariff hike on China increases PCE inflation by 0.5pp in year 1 and 0.1pp in year 2. This tariff is now in force and unlikely to be removed soon, and so it should be included in forecasts with estimates likely close to that from the staff paper.
We also expect that growth forecasts will edge down because of weaker data in Q1 2025. That said, the FOMC seems unlikely to incorporate a more comprehensively downbeat or recessionary forecast at this point, despite recent market narratives. We think policymakers will want to see much more evidence in economic data before making a more far-reaching reassessment of growth.
The unemployment rate forecast should remain steady despite a softer growth outlook, incorporating the effects of both tighter expected immigration policy and somewhat weaker productivity gains associated with tariffs. According to the staff research note on tariffs, productivity growth is expected to slow when tariffs rise on intermediate goods (i.e. inputs to US manufacturing), as has now occurred. We believe the unemployment rate forecast now takes on outsized importance in light of Powell’s recent speech (discussed below).
The median estimate for the fed funds rate will remain at two cuts in both 2025 and 2026, in our view. As we expect no cuts in 2025 absent an economic downturn, we naturally think that the FOMC’s rate forecasts will need to move up over the year. However, our guess is that this will happen later in 2025, when tariff-related inflation is appearing more clearly in the economic data.
We believe the long-run fed funds outlook will remain at 3.0%, albeit with upside risk. For a fifth consecutive increase in the long-run estimate to 3.1%, two of the three people in the 3.0% camp would need to nudge their estimates upward (or others upward from the below 3.0% set) to get there.
We expect Powell’s Q&A to focus on the labor market as a key signpost going forward for timing a resumption of rate cuts, leaning heavily on the framework he laid out in his 7 March remarks.
The key portion of that speech was as follows (emphasis added): “If the economy remains strong but inflation does not continue to move sustainably toward 2 percent, we can maintain policy restraint for longer. If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we can ease policy accordingly. Our current policy stance is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.”
This paragraph of text suggests two things to us. First, the FOMC seems comfortable remaining on hold until becoming convinced that uncertainty about the effect of tariffs is largely behind us. Our view is that this will be when the peak in tariff-related inflation has passed, probably in early 2026. Second, the most likely trigger for rate cuts restarting earlier is a rise in the unemployment rate above the “expected” 4.3% median end-2025 forecast included in the December 2024 SEP.
We see the labor market as critically important due to its interaction with tariff-related inflation. The FOMC is seemingly comfortable looking through a so-called one-time price shock, but less so with significant second-round effects. (Second-round effects are when price rises in some goods – such as imported goods – result in price rises in other goods, services or wages.) We have long expected much second-round inflation, but this is uncertain and will depend on the macroeconomic environment. Second-round effects will likely be greater should workers have more bargaining power in a tight labor market to maintain their real incomes, and lesser if the labor market is loosening.
We read Powell’s 7 March remarks as signaling (to both markets and the Trump administration) that he has no intention of either obscuring negative economic effects of the administration’s policies or using monetary policy to pre-emptively reduce these impacts. The remarks were clear and candid in listing the areas of policy change and indicating that they were generating uncertainty. Powell also stated repeatedly that monetary policy would respond only after a patient and deliberate analytical process that is unhurried, awaits clarity, is driven by “signal” rather than “noise,” and responds to an evolving economic outlook.
We see this approach as an effort to address risks of further erosion in long-term inflation expectations. A straight read of the post- pandemic University of Michigan survey data, for example, is that more and more Americans have set aside the FOMC’s 2% y/y inflation target in forming their inflation expectations. These Americans instead seem to believe that inflation is primarily an outcome of a political process at the Presidential level, with the Federal Reserve an arm of the Administration, and with the only remaining area of debate how much inflation will ensue from the Administration’s agenda. This outcome, if allowed to become cemented and even more widely held, risks undoing the multigenerational project of building a sound currency and a credible, independent central bank in the US, dating all the way back to the 1951 Fed-Treasury Accord. It is not a legacy that Powell would find remotely acceptable as he moves toward his final year in office, we think.
Broadly speaking, there are two ways to assert – or in this case, reassert – independence in monetary policy decision-making. One is to do so verbally, making it unmistakably clear that the FOMC would speak accurately1 and clearly about the economy, the catalysts driving its evolution, and the policy steps required to achieve the committee’s mandate. The alternative approach is via action, and Powell was unequivocal on 7 March that he would respond immediately and “very aggressively” to scenarios where “inflation expectations were clearly under pressure,” even if economic uncertainty was high, “because of the potential cost of not doing so.” We expect that Powell will continue to project independence, both in word and in future action if needed, at his press conference.
FOMC members seem widely supportive of rates staying unchanged next week. Many Fed officials have noted that the US economy is well placed to await more clarity
