The new economic forecasts released by Federal Reserve officials this week will provide the most concrete evidence to date on how the Federal Reserve views the impact of Trump administration policies. These policies have cast a shadow over the previously robust economic outlook.

Top forecasting institutions have lowered their growth expectations for the USA economy this year, raised their assessments of the risk of recession, and expect inflation to rise as President Trump's severe new tariffs on imports spread through the global market. Broader tariffs are expected to be implemented next month.

As uncertainty over the forecasts increases and the stock market plummets, a more severe situation suddenly arises.

The Chief Economist of Bank of America, Beth Ann Bovino, stated: "A 'soft landing' is still possible, meaning the economy continues to grow while inflation falls back to the Fed's target of 2%. However... we are starting to see some impacts. The trade war... Consumer expectations are showing concerns about recession and inflation."

Bovino noted that if the tariff plans of the Trump administration reignite the price pressures that the Federal Reserve is trying to curb, there is uncertainty around the Fed's policies. "The situation is still not bad, but the shocks are beginning to accumulate."

These shocks include the painful sell-off in the USA stock market, with the S&P 500 Index entering a technical correction last week, down 10% from its record high in February. While Federal Reserve officials typically downplay the impact of asset price volatility on monetary policy decisions, extreme fluctuations draw attention as they can indicate a loss of confidence and foreshadow a decline in consumer spending as household wealth shrinks.

The Federal Reserve is expected to maintain its benchmark interest rate in the range of 4.25%-4.50% at the meeting that concludes on Thursday. This rate has remained unchanged since December of last year, when the median forecast of policymakers was for two rate cuts of 25 basis points in 2025; investors currently anticipate three rate cuts.

Updated Outlook

In December last year, officials' median expectation was that the USA economy would grow by 2.1% this year, with the unemployment rate rising slightly to 4.3% by the end of the year, and the PCE price index (the Federal Reserve's preferred inflation Indicator) reaching 2.5% by year-end.

However, these forecasts were released before Trump's policy plans became more specific, which included imposing a new 25% tax on imported Steel and Aluminum, and a 25% tax on most Commodities from Mexico and Canada, which will take effect next month, alongside Global "equivalent" tariffs (i.e., tariffs that match those imposed by other countries on USA goods) that are also set to be implemented.

Trump's plans are complex, and some have compared them to the tariffs implemented in the 1930s that exacerbated the Great Depression; members within the Trump administration have also indicated that painful adjustments may occur.

The public statement before the meeting pointed to three developing scenarios: inflation slowing or economic weakening, allowing for further rate cuts; inflation remaining persistently above the Federal Reserve's target, keeping monetary policy tight for a longer time; and inflation still exceeding expectations, but the economy is also slowing. The last scenario presents a potential dilemma, possibly forcing the Federal Reserve to choose between inflation and employment targets.

Economists at Deutsche Bank pointed out in a recent analysis that Federal Reserve officials will have to make several difficult determinations. For instance, it is hard to figure out which tariff price effects will dissipate on their own and which will persist. The rising unemployment rate may initially reflect mild softness, but as layoffs lead to weaker demand, resulting in more layoffs and even softer economic activity, it may spiral upward, worsening the situation.

Analysts said that inflation expectations may have stabilized at present, but "greater dispersion and uncertainty... indicate poor stability."

Matthew Luzzetti, the chief U.S. economist at Deutsche Bank, and his team wrote: "Either the economy remains resilient, and high inflation effectively keeps the Federal Reserve on hold, or significant cuts in government jobs combined with hiring freezes in the private sector due to trade uncertainty lead to a sharp deterioration in the labor market, necessitating larger rate cuts. It is not easy to determine which path is the correct one."

Although their baseline scenario is "flexible growth and sticky inflation," and they will keep interest rates unchanged at this meeting, the rising risk of economic recession has become a part of the discussion.

Wider tail risks.

Satyam Panday, chief economist for the USA and Canada at S&P Global Ratings, wrote: "Supply side shocks from tariffs, slowing immigration growth trends, and federal workforce reductions are increasingly likely to form a lasting negative feedback loop that undermines overall demand." Panday estimates that the risk of an economic recession in the USA over the next 12 months is 25%, double the normal level.

In a recent survey by foreign media, economists almost unanimously agreed that the risk of recession has risen.

This may not immediately appear in the new economic forecast summary released by the Federal Reserve on Thursday. Since recent data is still good, and Trump's plans are constantly changing (in some cases facing court-ordered reversals), policymakers' positions may not change significantly.

EY Chief Economist Gregory Daco expects that the median forecast for the Federal Reserve's policy rate will remain the same as two 25 basis point cuts this year, as it was in December last year, while expecting economic growth to slow slightly, the unemployment rate to rise slightly, and the year-end inflation forecast to remain at 2.5%, the same as in December last year.

However, the divergence of views among policymakers may also begin to widen, reflecting decreased confidence in the baseline forecast, increased risks, and rising uncertainties—all of which are reflected in a separate survey of policymakers released alongside the forecasts.

During the COVID-19 pandemic, these surveys sometimes consistently indicated that the outlook was more uncertain than usual, but conditions have been improving. On March 7, when Federal Reserve Chairman Powell spoke in New York, he mentioned the implicit tail risks in the economy and society, thereby establishing the current tone. Powell stated:

Human nature is that we always talk about how uncertain our understanding of things is. We keep saying that tail risks are bigger than you think.

Editor/rice