Summary:
Bank of America (BofA) Global economists warn that if something is going to break in the U.S. economy, it will likely happen this summer. In their base-case scenario, the labor market stays strong, and Donald Trump’s proposed tariffs push inflation high enough to prevent the Federal Reserve from cutting interest rates in 2025.
However, they also outline a risk scenario: if economic cracks appear by the end of summer, the Fed could respond with a 75 basis point rate cut starting in September.
The Fed itself appears split. Half of the Federal Open Market Committee (FOMC) expects no rate cuts until 2026, while the other half anticipates two cuts in 2025, possibly beginning as early as July or September. Fed Governors Christopher Waller and Michelle Bowman have both signaled openness to cuts soon.
BofA economists doubt the “Goldilocks” outcome (low inflation and steady job market) suggested by the Fed’s median forecast, calling it unrealistic. They also note that previous Fed forecasts in June (2019, 2022, 2024) failed to predict rate changes later in the year.
Fed Chair Jerome Powell has said the central bank will wait for more clarity on tariff impacts before changing policy. Meanwhile, other economists, like Neil Dutta of Renaissance Macro, are more concerned about a weakening labor market than inflation.
Despite these warnings, U.S. stock markets remain strong, with the S&P 500 near record highs, even amid rising jobless claims and softening labor indicators.
Fed May Face Two Diverging Paths in 2025, Say BofA Economists
According to BofA Global economists, there are likely two distinct paths ahead for U.S. monetary policy in 2025. “If something is going to break in the economy, we think it will happen over the summer,” said BofA economists Aditya Bhave and Shruti Mishra in a report shared with MarketWatch.
Their base-case scenario assumes the labor market holds up. In that case, President Donald Trump’s proposed tariffs would likely create enough inflation to keep the Federal Reserve from cutting interest rates at all next year.
A Break This Summer Could Trigger Rate Cuts
But BofA’s team also sees risk on the horizon. “We think the outlook is bimodal. If the labor market holds up as we expect, there will probably be enough tariff-driven inflation to prevent the Fed from cutting. But if something is going to break in the economy, we think it will happen over the summer,” Bhave and Mishra noted.
Should the latter scenario materialize, they expect the Fed would respond swiftly by slashing interest rates by 75 basis points beginning in September.
Fed’s Forecasts Show Division Over Policy Direction
BofA’s outlook diverges from what senior central bankers have recently signaled. As Bhave and Mishra observed, “Nearly half of the members of the Federal Open Market Committee who contributed forecasts to the central bank’s latest ‘dot plot’ expect the Fed will remain on hold at least until next year.”
The remaining half expect at least two rate cuts in 2025, with the first likely to arrive in September. Fed Governor Christopher Waller has indicated the central bank could cut rates as early as July. On Monday, Governor Michelle Bowman said she would support a rate cut at the Fed’s next meeting.
“Goldilocks” Scenario Unlikely, Say Economists
The BofA Global team cast doubt on the realism of the so-called “Goldilocks” scenario represented by the median dot on the Fed’s forecast chart — an ideal setting of low inflation and a labor market that’s cooling only modestly.
“The expectations reflected by the median dot… seem unrealistic: Such a scenario would likely involve a ‘Goldilocks’ combination of tepid inflation and a labor market that is modestly cooling but not substantially weakening,” Bhave and Mishra wrote.
Fed’s June Forecasts Have Missed Before
The economists questioned the predictive value of the Fed’s dot plot: “At the June meetings in 2019, 2022 and 2024, not even one FOMC participant correctly forecast the change in policy over the rest of the year,” they said. While the dots have been more accurate in other years, they emphasized, “forecasting is just very difficult in periods of elevated economic uncertainty.”
Powell Cautious on Tariffs and Inflation
Fed Chair Jerome Powell reiterated during congressional testimony on Tuesday that the central bank will likely remain on hold until it gains more clarity on how Trump’s tariffs might influence inflation.
Warnings from Other Economists
Other experts see different risks. “Right now, the FOMC does not appear to be especially concerned about the labor market but [is] quite concerned about the outlook for consumer prices. I take the opposite view, with heightened concern about the labor market,” said Neil Dutta, an economist at Renaissance Macro.
Dutta also pointed to signs of sluggish business investment, aside from spending related to artificial intelligence.
Market Still Resilient for Now
Despite concerns, markets remain steady. “So far, U.S. stocks haven’t exhibited signs of much strain despite some softness in the labor market, including a recent uptick in weekly jobless claims,” the article noted.
The S&P 500 was recently trading at 6,077, up 0.9% on the day — placing it within striking distance of its record closing high from February.
Source: MarketWatch
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