The Federal Reserve is driving blindfolded.
That’s my single most important takeaway from the central bank’s big policy announcement on Wednesday. On the predictable side, the Fed kept policy rates in a range of 4.25%-4.5%, and the rate-setting committee pledged to slow the pace at which it’s allowing securities to roll off its balance sheet. The median Fed participant only subtly updated baseline economic projections for 2025 to show 2.7% PCE inflation (versus 2.5% in December’s outlook), 4.4% unemployment (compared with 4.3%), and 1.7% growth in gross domestic product (versus 2.1%). The projections suggested 50 basis points of rate cuts this year, unchanged from the previous estimate. But the most jarring development was the number of Fed board members and Federal Reserve Bank presidents who reported heightened uncertainty around their outlooks for joblessness, inflation and GDP.
Sixteen of 19 respondents now say that the uncertainty around their unemployment projections is higher than typical levels of forecast uncertainty in the past two decades. Seventeen respondents said the same of their inflation forecasts, and 17 said uncertainty was elevated for GDP. This combination of uncertainties is rare and quite concerning in and of itself. It should lead financial markets to demand higher risk-premia via wider credit spreads and lower price-earnings multiples. The Fed has been publishing its survey of projections for a decade and a half, and the only other analogous period fell between the onset of the Covid-19 pandemic in 2020 and early 2023. Only then did we seen uncertainty around unemployment, inflation and GDP this elevated simultaneously.
What’s making economic forecasting so precarious? By and large, it’s President Donald Trump’s haphazardly conducted global trade war and equally scattershot approach to government downsizing. That includes Elon Musk’s Department of Government Efficiency, which has led to on-again, off-again government layoffs and spending cuts that have triggered several legal challenges. How these moves will affect the private sector is to be determined.
On tariffs, prognosticators are struggling to understand the logic and legal basis behind Trump’s so-called “reciprocal tariff” plan set for April 2. Trump has said that the policy will lead to the US raising tariffs on countries that have tariffs, value-added taxes and other non-tariff barriers that he perceives as harming US producers. But as with other elements of Trump’s economic agenda, policymakers can’t know for sure which parts of the plan will withstand legal scrutiny. Nor can they differentiate the “negotiating tactics” from the tariffs that are intended to remain in place for the long haul. If they can figure those things out, they next need to decide how firms and households will absorb higher prices. Will tariffs primarily lead to shrinking profit margins, or will firms pass costs on to consumers? Will consumers grit their teeth and pay more, or will they cut back on spending?
One prominent view suggests that tariffs constitute a form of supply shock and that monetary policy authorities should “look through” them — effectively, they should ignore this one-off adjustment. The stability of the Fed’s rate projections suggests that it is leaning toward doing just that. Chair Jerome Powell, however, said that there are a lot of crosscurrents influencing the outlook. When it comes to changing forecasts for rates in “this highly uncertain environment,” he said, “I think there’s a level of inertia where you just say ‘maybe I’ll stay where I am.’”
But opinions vary. A model-based analysis by economists from the Federal Reserve Bank of Minneapolis and the University of Wisconsin-Madison recently showed that the optimal policy response is to stimulate the economy via rate cuts; indeed, that’s what the Fed ended up doing after Trump carried out a previous round of tariff escapades in 2019. Others would say it all depends on how other countries retaliate and whether domestic inflation expectations increase. There’s some evidence that consumer inflation expectations are indeed on the rise, as David Wilcox, Bloomberg Economics’ director of US research and a former senior advisor to three Fed chairs, wrote on Tuesday.
So what do you do with that combination of facts? If you’re the Fed, you probably continue to do nothing and wait for more information. That means, unfortunately, that when policymakers finally swing into action, it could already be too late.
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