New GDP Report and Inflation Concerns Reinforce Fed's Wait-and-See Approach

The release of the fourth quarter GDP report on Thursday and the anticipated release of an inflation report on Friday are expected to reinforce the Federal Reserve's cautious stance on interest rates.

GDP Report Shows Strong Consumer Spending

Despite a weaker-than-expected headline growth rate of 2.3%, the GDP report highlighted positive signs in consumer spending, which grew at an annualized pace of 4.2%. This suggests continued strength in the consumer sector. However, volatility in the trade component, with both imports and exports declining, and a reduction in inventory accumulation impacted overall GDP growth.

Inflation Remains a Concern

While the Fed has adopted a wait-and-see approach to interest rates, inflation remains a concern for policymakers. The Personal Consumption Expenditures (PCE) index, a preferred gauge for the Fed, is expected to remain elevated at 2.8% in December. This is above the Fed's 2% target and may lead to a more cautious approach.

Fed's Next Move Uncertain

Fed officials have expressed concern about persistent inflation and have scaled back their estimated number of rate cuts for 2025 from four to two. While some economists believe a March rate cut is still possible, others forecast no cuts for the year. The next potential move could be a rate hike in 2026.

Trump Tariffs Could Impact Inflation

If President Trump imposes 25% tariffs on Mexico and Canada, as he has threatened, it could drive core PCE inflation up to 3%. This emphasizes the Fed's cautious approach as they assess the potential impact of the Trump administration's economic policies.

Conclusion

The GDP report and upcoming inflation data will further inform the Fed's wait-and-see approach on interest rates. While the economy remains strong, inflation remains a concern, and the potential impact of Trump tariffs adds to the uncertainty.