The Big Idea
FOMC’s surprising optimism
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When the FOMC publishes new economic projections, most economists and financial market participants compare them to the prior 3-month-old estimates. While it helps to watch how Fed forecasts evolve, a more informative point of reference is the evolving differences between FOMC projections and the private sector consensus. Ironically, despite frequent protestations from administration officials that the Fed is factoring in too much of a growth drag and excessive inflation associated with tariffs, in reality the FOMC is more optimistic than private forecasters on GDP growth, the labor market and inflation in 2025.
FOMC projections
The FOMC releases economic projections on a quarterly basis along with the more closely followed policy projections, the so-called “dot plot”. The usual analysis of these figures entails comparing the latest forecasts with those of the prior quarter, a practice that is consistent with the way the FOMC displays the estimates (Exhibit 1).
Exhibit 1: FOMC June Economic Projections
Source: Federal Reserve.
The main narrative coming out of the recent FOMC meeting was that the Fed had lowered its 2025 growth projections (the median fell from 1.7% to 1.4%), raised the unemployment rate estimate (from 4.4% to 4.5%), and bumped up inflation forecast considerably (by three tenths for both the headline and core PCE deflator). The natural conclusion, which is broadly true, is that Fed officials have downgraded their economic projections due to the news on tariffs since mid-March, when the previous forecasts were released.
This naturally created friction between the FOMC and the White House, as President Trump and administration officials pushed a narrative that tariff hikes would not have any adverse impact on the economy or push up inflation, even temporarily.
FOMC versus private sector consensus
In my view, a better way to assess FOMC projections are to compare them to contemporaneous private sector forecasts. Presumably Fed officials and private sector forecasters are adjusting their estimates based on broadly the same information. So, differences between the two offer insight on what the FOMC may see differently from everyone else.
Looking through that prism, Fed officials are actually more upbeat about the near-term economic outlook than other forecasters. The median FOMC forecast in June for real GDP growth this year was 1.4%, which is double the consensus from the June Blue Chip Economic survey (+0.7%). This means that Fed officials are presumably penciling in a substantially smaller economic drag from tariffs for 2025 than private sector forecasters. Similarly, the FOMC projection for the unemployment rate in the fourth quarter of this year was 4.5%, slightly lower than the Blue Chip consensus of 4.6%.
In other words, despite all of the political flak that Chair Powell is taking from the Trump administration and others in Washington for pinning too much significance to the fallout from tariffs, Fed officials are actually offering an outlier upbeat view on economic growth for this year and a somewhat brighter forecast for the labor market.
The story is consistent regarding inflation. Chair Powell has been criticized by administration officials and by a number of Republicans on Capitol Hill during his recent semi-annual testimony for suggesting that tariffs are likely to generate higher inflation in the coming months. However, the FOMC’s median forecast for headline and core inflation as measured by the PCE deflator in 2025 were 3.0% and 3.1%, respectively, lower than the corresponding June Blue Chip estimates of 3.2% and 3.4%.
The temporary inflation burst that the FOMC projects is noticeably smaller than what is forecast by private sector economists. Chair Powell might have saved himself a certain degree of political grief if he had emphasized this gap between FOMC projections and those of private sector economists during the FOMC press conference and his recent Congressional testimony.
Aligning with the FOMC
For what it is worth, my own 2025 economic projections align more closely with the FOMC’s than the private sector Blue Chip consensus even though I participate in that survey. In fact, if anything, I have even more upbeat estimates than the FOMC, though only marginally. I expect real GDP growth of 1.5% on a Q4/Q4 basis in 2025 and for the unemployment rate to average 4.4% in the fourth quarter of this year. On inflation, my Q4/Q4 forecasts are 2.9% for the headline PCE deflator and 3.0% for the core PCE deflator, a tenth lower than the FOMC median and well below the Blue Chip consensus.
I cannot speak to exactly what assumptions are driving the FOMC or the private sector consensus figures, but my guess is that my relative optimism stems from a view that the administration will ultimately settle on a relatively benign tariff menu, similar to what is currently in place, and will largely resolve the issue before the end of this year, limiting the drag to the economy created by policy-related uncertainty.
Translating economic projections to monetary policy
As always, getting the economic projections right certainly would give forecasters a leg up on predicting the Fed’s rate decisions for this year and next. However, in the current circumstances, the differences in projections between Fed officials and private forecasters will likely prove to be of secondary importance. In a more normal economic landscape, the Fed would make their rate decisions based in part on their projections for the economy and inflation. However, policymakers have made clear that, in light of elevated uncertainty, they are currently unwilling to proceed based primarily on their forecasts. Instead, they are patiently waiting for clarity, a luxury that the FOMC is afforded by the fact that the economy and the labor market, at least for now, remain solid.
As the economy evolves, and, in particular, as inflation figures for the next few months establish once and for all how much tariff hikes will pass through to consumer goods prices, the policy leanings of the FOMC will evolve accordingly. I expect the economy to muddle through to the point that the FOMC will not be forced to slash rates to avert a recession. This will allow policymakers to maintain their focus on inflation. Assuming that tariffs generate a significant temporary boost to prices over the next few months, Fed officials will be eagerly waiting to see when and whether that burst upward in inflation abates. I suspect that as soon as evidence of a return to normal in the monthly inflation figures emerges, the FOMC will look to cut rates modestly further. Based on this outlook, I continue to pencil in two quarter-point rate cuts from the Fed before the end of 2025, though, if the tariff-related jump in inflation emerges later than I expect or takes longer to dissipate, then the timing of the easing could be pushed back by a few months.
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