Federal Economic Forecast Indicates Potential Stagflation Worries

Federal Economic Forecast Indicates Potential Stagflation Worries

The Federal Reserve hasn't altered its interest rate predictions this week, yet their economic outlook took a slight change in their recent projections. The Federal Open Market Committee's economic projections hint that the Fed might lower interest rates two more times, totaling half a percentage point, over the remaining months of the year. These projections align with their earlier forecasts in March and towards the end of last year.[1]

However, not everything remains as it was in the previous projections. The Fed's projection reflects unemployment and inflation afflictions that are higher than officials previously expected.

This points to the Fed's reasoning behind its wait-and-watch approach. Although the inflation rate is closing in on its yearly 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 suggest that the FOMC sees a bit more stagflation than it did in March," said Wells Fargo Chief Economist Jay Bryson.

The Unemployment Rate

What it indicates: More officials forecast unemployment will climb higher in 2025, with most now projecting an unemployment rate of around 4.4% - 4.5% this year, raising the median projection to 4.5%. The unemployment rate stayed steady at 4.2% in May, fresh data revealed. Officials anticipate unemployment to remain close to 4.5% in 2026 and 2027. Both forecasts are higher than the March projection.

What it implies: Officials don't foresee a breakdown in the job market upcoming, though unemployment may inch higher than initially predicted. With a robust job market propelling the economy, Fed officials have more leeway to keep interest rates high in order to bring the Personal Consumption Expenditures (PCE) inflation rate back to its 2% target.

"From the Fed's viewpoint, substantial ongoing uncertainty coupled with a satisfactory-enough labor market presents adequate justification for its wait-and-watch approach," said Indeed Senior Economist Cory Stahle.

The PCE Inflation Rate

What it says: Inflation will worsen before getting better. Fed officials project the median PCE inflation rate will hit 3% in 2025, an increase from the median rate of 2.7% forecasted in March. Projections for 2026 and 2027 were also higher than the March forecast and indicate that officials expect inflation to persistently stay above the Fed's goal of 2%.

What it means: Officers likely factor in projected price increases due to tariffs, consequently causing higher inflation over the coming years. Even though the Fed's projections indicate that price pressures might linger, it didn't prompt them to significantly modify their interest rate projections.

"Their revised quarterly forecasts suggest they continue to be dovish and tend to look beyond a temporary spike in inflation and cut rates by 50 basis points this year to bolster a predicted weakening in economic activity," wrote Nationwide Chief Economist Kathy Bostjancic.

The Fed Funds Rate For The Rest of 2025

What it says: The dot plot shows that FOMC members are split on where interest rates are headed.

The top row indicates that seven of 19 members anticipate rates staying unchanged at 4.25% to 4.5% throughout the remaining months of the year. Another row of eight votes indicates the Fed will implement two more interest rate cuts, reducing rates to approximately 3.75% to 4% by the end of the year. Only four members foresee a different outcome for the Fed. averaging their expectations, the average projects a half-percent interest rate cut this year.

What it means: Essentially, the results indicate that despite a retreating inflation rate and continuous strong job growth, more members are wary about whether interest rates need to be lowered at all. The dot plot shows that the number of members who doubt the Fed will lower rates 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 eager to cut rates, but appear ready to do so if the right conditions arise," said eToro U.S. Investment Analyst Bret Kenwell.

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In general:

The Federal Reserve's revised interest rate outlooks for the remainder of 2025 imply that the central bank expects to maintain rates fairly steady near their current range of 4.25% to 4.5% for much of the year. Among Fed officials, seven of 19 members foresee rates staying unchanged at this level throughout 2025, while eight members anticipate two rate cuts, lowering the funds rate to around 3.75% to 4% by year-end.[1][5]

Even though there is an expectation of subsequent rate cuts, the Fed remains cautious about loosening monetary policy excessively. Their caution primarily originates from concerns about unrelenting inflation and a weakening economic perspective. Inflation projections for 2025 have been revised upward from 2.7% to 3.0%, showing that price pressures remain stronger than anticipated earlier in the year.[1][5] Moreover, the Fed must grapple with an environment of slower growth and heightened uncertainty. The central bank's updated economic forecast includes higher unemployment and inflation, signaling some stagflation risk. This risk refers to when inflation remains high even as economic growth weakens.[5]

The Fed's reluctance to slash rates immediately is also influenced by external uncertainties, such as tariff impacts and political factors that could further exacerbate inflation and workforce market instability. Fed Chair Jerome Powell has stated that tariffs may cause prices to rise in the coming months, implying consumers have yet to fully experience the cost increases from the import duties.[4] This inflationary pressure might delay or diminish the number of rate cuts, maintaining borrowing costs elevated and mortgage rates high for longer.[4]

In summary:

• The Fed projects 2 rate cuts in 2025, potentially bringing rates down to approximately 3.75%-4%, but a significant portion of officials expect rates to stay at their current levels (4.25%-4.5%) throughout the year.[1][5]
• Inflation forecasts were revised up to 3.0% for 2025, propelling the cautious stance on rate cuts.[1][5]
• Worries about stagflation, tariff-induced inflation, weaker growth, and labor market risks make the Fed hesitant to lower rates quickly.[4][5]
• The Fed follows a "wait-and-see" approach, balancing the dual responsibilities of price stability and full employment amid uncertain economic conditions while avoiding premature easing that could rekindle inflation and being prepared to cut rates if economic conditions worsen significantly.

1. In light of the Fed's revised projections, there might be an opportunity for new businesses in the finance sector to issue ico and token sales, as the projection of lower interest rates could make borrowing more attractive.
2. The increased expectation of higher unemployment and inflation rates could impact certain business sectors differently. For instance, businesses heavily reliant on personal consumption may need to re-evaluate their financial strategies due to the anticipated inflation, while those focusing on budget-conscious offerings could potentially thrive during this period.

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