GDP Data and Inflation Concerns Shape Fed's Cautious Approach

The recent GDP report and anticipated inflation reading from the Personal Consumption Expenditures (PCE) index reinforce the Federal Reserve's wait-and-see stance on interest rates. Fed Chair Jerome Powell emphasized the less restrictive policy stance and strong economic conditions, indicating no immediate rush to adjust policy.

Strong Consumer Spending Amidst Volatility

The fourth-quarter GDP report revealed a 2.3% annualized growth rate, with robust consumer spending growth of 4.2%. However, the trade component exhibited volatility, with imports and exports declining by 0.8% and inventory accumulation subtracting 0.9% from overall growth. Experts attribute this volatility to anticipation of Trump administration tariffs and a strike at Boeing. Equipment investment declined by 7.8%, primarily in aerospace.

Inflation Concerns Linger

Despite a strong consumer, inflation remains a concern for policymakers. Core PCE inflation is projected to remain unchanged at 2.8% for December, with a monthly increase of 0.2%. Fed officials have expressed growing concern about persistent inflation, prompting a reduction in estimated rate cuts for 2025 from four to two.

March Rate Cut in Question

While some economists believe a March rate cut remains possible, others see no cuts this year. EY chief economist Greg Daco emphasizes that inflation is still converging toward the Fed's 2% target, leaving room for further policy easing if inflation eases convincingly. However, Deutsche Bank's Matt Luzzetti predicts no cuts this year and a potential rate increase in 2026.

Trump Tariffs and Inflation Impact

If President Trump imposes 25% tariffs on Mexico and Canada, Luzzetti anticipates a rise in core PCE inflation to 3%. This highlights the uncertainties that the Trump administration's economic policies pose for the Fed, leading to a cautious approach to policy adjustment.