US economy has strong momentum, but policy uncertainty clouds the outlook

The American economy has entered 2025 with a strong head of steam. We estimate that real GDP grew at an annualized rate of 2.7% in the recently completed fourth quarter of 2024, and the economy ended the year on a strong note by creating 256K net new jobs in December.

Most businesses are in solid financial shape. The pace of gross hiring has downshifted in recent months, but most firms do not need or want to cut staff.

Progress on returning inflation to the Fed's target of 2% has slowed. The year-over-year change in the core PCE deflator, which most Fed officials believe is the best measure of the underlying pace of consumer price inflation, edged up from 2.6% during the summer to 2.8% in November.

The economic outlook for 2025 is clouded by the potential for changes in U.S. trade policy. Although President Trump may not necessarily impose a universal tariff on American trading partners when he takes office, the probability of higher levies in coming months is not insignificant, in our view.

Higher tariffs, should they be imposed, would impart a modest stagflationary shock to the economy. That is, inflation could potentially pick up and real GDP growth could slow. Higher prices would erode growth in real income, thereby weighing on growth in real consumer spending.

We have made some adjustments to our outlook for U.S. monetary policy due to the economy's strong head of steam recently and slow progress in returning inflation to 2%. We now think the FOMC will remain on hold for an extended period of time. We look for only two 25 bps rate cuts this year: the first in September and the second in December. Then, we think the Committee will keep its target range for the federal funds rate unchanged at 3.75%-4.00% throughout 2026.

The levying of tariffs could present the FOMC with a policy conundrum. If the Committee responds to an uptick in inflation with tighter policy, then the unemployment rate could rise. On the other hand, however, if the FOMC tries to offset the growth-slowing effects of tariffs with more accommodative monetary policy, then inflation could tick even higher.

We should learn more about the policy choices of the Trump administration in the coming weeks and months, and we will be prepared to make adjustments to our outlook, if necessary, as those details become known.

Download The Full US Economic Outlook