Fed Keeps Rates and Anticipates Inflation (Albeit Temporary)
Key Takeaways:
- As anticipated, the Federal Reserve maintained its overnight rate target range at 4.25% to 4.50%.
- The next policy meeting is scheduled for May.
- Fed officials expect a modest rise in inflation, alongside a slight decline in GDP growth.
- Chairman Powell highlighted that the inflationary impact of tariffs is likely temporary. However, he acknowledged the difficulty of making accurate forecasts in an environment of significant trade policy uncertainty.
- Equity market volatility is expected to persist until investors gain clarity on tariff policies, which will allow for more reliable economic forecasts.
Fed Maintains, as Expected
The Federal Reserve’s FOMC maintained the federal funds target rate at 4.25% to 4.50%, as expected. The Fed seems relatively cautious about still above-target inflation, expected at 2.7% for 2025 compared to the 2% target.
Despite maintaining its policy rate, the Fed is slowing quantitative tightening (QT) by reducing the cap on Treasury securities to be sold per month to $5b from $25b (Agency MBS remains at $35b). Although Chairman Powell indicated this is about balance-sheet management, not a policy decision, the slower supply of Treasury paper could marginally help lower long-term rates.
Inflation - Temporary or Persistent? Data Holds the Answer
Chairman Powell noted that the inflationary effect of tariffs is likely temporary, but forecasting is challenging, as “uncertainty is remarkably high.” The Chairman highlights the gap between forward looking surveys that skew negative, and actual data. measurements that remain stable.
We anticipate that the tug-of-war between whether tariffs have a permanent or passing effect on inflation will run throughout 2025. We favor forward-looking variables like sentiment, investment, and new hires as a better way to anticipate the evolution of the economy. As of now, most leading indicators have reacted negatively to the changes in trade policies, and - in coincidence with the Fed boardmembers’ forecasts - point at a worsening economic picture for now. But that could change if tariffs are a one-off change in price levels, rather than a feedback loop in which expectations-feed-inflation and inflation-feed-expectations.
The “poll” of Fed’s board members yielded a slightly negative drift on both inflation and growth. The median forecast expects GDP to grow at 1.7% and 1.8% in 2025 and 2026, respectively, from the 2.1% and 2.0% projected in December. At the same time, 2025 PCE inflation forecasts climbed to 2.7% from 2.5%
Investors - It's Going to be a Bumpy Ride
Stock market volatility is likely to persist through the summer. The challenge for investors lies in the difficulty of assigning probabilities to various outcomes, each of which could have vastly different impacts.
For instance, a relatively normal scenario could involve the Fed cutting rates by 25 basis points if inflation moderates from 2.7% to 2.3%, potentially moving equity markets by 5% to 7%. However, the stakes rise significantly with more extreme scenarios, such as stagflation—characterized by rising inflation and stagnant growth—reminiscent of emerging-market dynamics. Conversely, a swift recovery may unfold if tariffs stabilize price levels and the economy adjusts.
