Revising our Fed rate call and our growth scenarios

The Federal Open Market Committee’s decision at its last meeting to hold its policy rate at 3.5% to 3.75% reflects uncertainty regarding the impact of tariffs on inflation and a softening labor market.

Financial markets retained much of the same sentiment, with the forward markets expecting the Fed to wait at least until its July meeting to enact another rate cut.

We are updating our rate forecast to one 25-basis-point rate cut at the July or September meeting.

One variable at play is the appointment of a new Federal Reserve chair to replace Jerome Powell, whose term ends in May.

The noise around the central bank’s independence will most likely lead the new Fed chair to eschew a rate cut at the June meeting to avoid giving the impression that the executive branch is guiding policy rate. In that case, a rate cut is more likely in July.

In addition to updating our rate forecast, we are revising our base case outlook for the economy and our two alternative scenarios:

• Base case: Expansionary fiscal policy should keep spending on a strong footing while continuing deregulation will support an enhanced risk appetite and increased business expansion beyond a robust tech sector. Rising overall demand will keep inflation around 3% while the unemployment rate stabilizes around 4.4%.
• Dovish alternative: A government shutdown, continuing geopolitical tensions and rising trade uncertainty are key risks to the economy. If those risks take hold, spending growth will fall below expectations while the labor market weakens. In addition, upcoming benchmark employment revisions could prompt the FOMC to pull forward the number and magnitude of rate cuts.
• Hawkish alternative: Fiscal tailwinds could have a greater impact than expected as tariff concerns ease. Inflation could stay above 3% for a while, giving the Fed no reason to cut rates and potentially shifting the balance of risks back toward rising inflation, which would create the conditions for a rate increase.

RSM uses four models to estimate the optimal policy rate for the American economy. None of the models implies that a rate cut is needed at this time. Our preferred model suggests that the current policy rate is 75 to 100 basis points too high.