Updated baseline
We have updated the baseline. We have revised our baseline scenario to reflect several key updates in assumptions and incoming data. In this iteration, we incorporate a more moderate shock to core import prices, based on the assumption that a significant portion of Chinese exports will be re-routed to circumvent the newly imposed 145% tariff. Additionally, we have reduced the assumed equity risk premium shock, incorporated higher long-term interest rates, and updated our inputs for Q1 core PCE inflation and export prices.
The outcomes of the revised baseline scenario are illustrated in Figure 1 and Figure 2, which display real-side and financial-side variables, respectively. In Figure 1, the red dashed line denotes the updated forecasts generated by FRB-US, while the blue dots represent the latest SEP.
Bottom Line: Elevated Recession Risk Amid Subdued Growth and Persistent Inflation. While the probability of a recession has declined, it remains meaningfully elevated—hovering around 35%. The outlook for 2025 points to sluggish real GDP growth, a gradual rise in the unemployment rate to approximately 4.8%, and a reacceleration in core PCE inflation, which is projected to exceed 3% and remain persistently above the Federal Reserve’s target. In essence, the projections illustrated in Figure 1 closely mirror the economic narrative outlined in the most recent FOMC meeting minutes (here), reinforcing a scenario of ongoing macroeconomic imbalances and policy uncertainty.
Figure 1. Update FRB-US forecast – real-side variables.
Note: Real GDP growth and core inflation are expressed on a year-over-year basis. Core inflation refers to core PCE price inflation. The red-dashed lines are the model forecast, while the blue dots are the latest SEP. This forecast has been updated as outlined in the text.
Figure 2. Update FRB-US forecast – financial variables.
Implications for Monetary Policy: The Case for Staying on Hold
In the context of our model projections, the Federal Reserve could, in principle, reduce the federal funds rate marginally toward the end of the forecast horizon—albeit to a significantly lesser extent than suggested by the Summary of Economic Projections (SEP). However, both the model output and recent public statements from Federal Reserve officials converge on a more cautious approach.
In our view, the central message is clear: the Fed is likely to remain on hold. The rationale is straightforward. In the current environment—marked by persistent inflation pressures and still-elevated expectations—the Federal Reserve’s foremost responsibility is to anchor inflation expectations credibly and durably. While this may appear counterintuitive, or even extreme, to some observers, the literature overwhelmingly supports such an approach: accepting some short-term economic pain is a prudent trade-off if it prevents the risk of a longer-term destabilization of inflation dynamics. (if you still have doubts, please see this tweet by Ricardo Reis)
This principle has been consistently echoed by multiple Federal Reserve officials in recent days, underscoring the institution’s commitment to maintaining price stability, even in the face of uncertain or mixed economic signals.