The Federal Reserve held its policy rate steady at its meeting on Wednesday but signaled that it expects economic growth to stagnate while inflation and unemployment head higher. Call it stagflation lite.
In holding the policy rate in a range between 4.25% and 4.5%, the Federal Open Market Committee also signaled the possibility of two rate cuts this year, although it’s a close call on that outcome.
The median rate forecast it its interest rate projections, or dot plot, is 3.9% this year, 3.6% next year and 3.4% in 2027.
But the view was hardly unanimous. Ten members of the FOMC indicated that they expect 50 basis points of cuts this year while seven indicated that they think there will be no cuts.
The Fed’s statement points out that risks to the outlook from both sides of the Fed’s dual mandate—price stability and maximum sustainable employment—are in focus.
For now, that outlook is sufficient to buy time until the FOMC gets a better read on the economy. A policy geared toward being all things to all people cannot endure for long.
Two scenarios are evolving. The first is that inflation driven through the trade channel will be transitory or that the policy rate is moderately restrictive, and the Fed can cut rates.
The second is that the central bank will need to signal to market participants and the White House that rates will remain on hold with the possibility of a rate hike should near-term inflation expectations increase.
Summary of Economic Projections
In downgrading growth projections for this year and next, the Fed expects trade policy to cause a modest drag on overall growth. Growth next year is expected to advance at a 1.6% pace and by 1.8% in 2027, according to the Summary of Economic Projections.
The committee anticipated that tariffs would cause inflation to deviate from its three-year descent back toward the Fed’s target of 2%.
The FOMC now expects inflation to reach 3% this year and then ease back to 2.4% next year and 2.1% in 2027. The core rate is expected to increase to 3.1% this year, then ease to 2.4% next year and 2.1% in 2027.
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For now, the Fed said that it expects the increase in inflation to be transitory and that inflation expectations will remain well anchored.
Should the latter not prove true, the Fed will find itself again behind the curve and need to prepare investors, policymakers and the public for elevated rates with risk of the federal funds rate moving higher.
Unemployment, which is 4.2%, is expected to remain historically low, increasing to 4.5% this year and next while falling back to 4.4% in 2027.
Given the changes in demographics and in immigration policy, we agree with the Fed that employment conditions will remain relatively tight by historical standards, which requires policymakers to monitor second-order effects on wages should there not be enough workers to meet demand from employers.
Policy statement
The statement was largely a status quo affair with the unemployment rate now described as remaining low and the economic outlook being characterized as diminished but still elevated.
Essentially, the statement reflects the Fed’s outlook that patience is a virtue when it comes to its policy. But Powell noted it is difficult to identify who will ultimately pay the tariffs given the role that producers, importers, sellers and consumers play.
Powell’s remarks
While the Summary of Economic Projections reflects the fundamental Fed view that tariff-induced inflation will prove transitory, Powell noted in his news conference after the meeting that tariffs will be the cause of inflation moving higher in the near term.
The takeaway
The Fed accomplished its primary objective, which was to buy time until it can ascertain the impact of the changes in trade, immigration and fiscal policy as well as the risks linked to the external sector on the domestic economy, like rising gas prices.
But it is impossible not to take away from the Summary of Economic Projections that the Fed expects a general economic environment resembling stagflation lite in the near term, which does not lift the fog of uncertainty that has enveloped the economy.
