Fed Foresees Stagflation, Higher Interest Rates Ahead
The Federal Reserve officials stuck to their interest rate expectations this week, but shifted their economic outlook in their latest economic projections.
The Federal Reserve Open Markets Committee's economic projections showed that the central bank is likely to cut interest rates two more times, or half a percentage point, throughout the rest of the year. The projections line up with similar forecasts in March and late last year.
However, not everything is the same as in prior projections. The Fed forecast shows unemployment and inflation rising higher than officials previously thought.
The projection underscores the Fed's reasoning behind its wait-and-see approach. Despite the inflation rate coming closer to its annual target of 2%, the Federal Reserve held rates at their current level of 4.25% to 4.50% on Wednesday.
'The summary forecasts that were published today imply that the FOMC sees a bit more stagflation than it did in March,' said Wells Fargo Chief Economist Jay Bryson.
What it says: More officials forecast unemployment moving higher in 2025, with most now projecting an unemployment rate of between 4.4% and 4.5% this year, sending the median projection up to 4.5%. The unemployment rate stayed at 4.2% in May, recent data showed. Officials see unemployment staying around 4.5% in 2026 and 2027. Both projections are higher than the March forecast.
What it means: Officials don't see a breakdown in the labor market ahead, though joblessness may tick higher than previously expected. With a solid labor market helping keep the economy strong, Fed officials see more time available to them to keep interest rates high in order to get the Personal Consumption Expenditures (PCE) inflation rate back to its 2% target.
'From the Fed's perspective, substantial ongoing uncertainty paired with a good-enough-for-now labor market is ample justification to continue its wait-and-see approach,' said Indeed Senior Economist Cory Stahle.
What it says: Inflation will get worse before it gets better. Fed officials now see the median PCE inflation rate moving to 3% in 2025, higher than the median rate of 2.7% forecasted in March. Projections for 2026 and 2027 were also higher than the March forecast and showed that officials expected inflation to remain above the Fed's goal of 2%.
What it means: Officials are likely factoring in expected price increases from tariffs, resulting in higher inflation over the next few years. While the Fed's projections indicate that price pressure may persist, it wasn't enough for them to significantly reduce their interest rate projections.
'Their revised quarterly forecasts indicate they remain dovish and inclined to 'look-through' a temporary spike in inflation and cut interest rates by 50 [basis points] this year to support an anticipated weakening in economic activity," wrote Nationwide Chief Economist Kathy Bostjancic.
What it says: The dot plot shows that FOMC members are divided on where interest rates are going.
The top row shows that seven of the 19 members see interest rates remaining unchanged at 4.25% to 4.5% throughout the rest of the year. Another row of eight votes shows that the Fed will cut interest rates two more times to bring them down to 3.75% to 4%. Only four members foresee a different result for the Fed. When taken together, the average projects a half-percent interest rate cut this year.
What it means: The results generally indicate that despite a declining inflation rate and continued strong job growth, more members are cautious about whether interest rates need to be cut at all. The dot plot shows that the number of members who don't believe the Fed will cut at all this year increased by three, while fewer projected that the Fed would cut by 50 basis points than in March.
'They don't seem to be in a hurry to cut rates, but appear open to doing so under the right conditions,' said eToro U.S. Investment Analyst Bret Kenwell.
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