What we are thinking

Economic Monitor – Weekly Commentary
by Eugenio Alemán

The Federal Reserve reserves the right to change its mind

May 9, 2025

Chief Economist Eugenio J. Alemán discusses current economic conditions.

It is very difficult for the Federal Reserve (Fed) to have any conviction at this time on the timing of interest rate moves when all the numbers on the economy, with probably the exception of soft data but especially consumer confidence and sentiment soft data, are still pointing to a strong economic backdrop.

Furthermore, what is happening in the economy is understandable because the tariff shock has been such that it has changed the behavior of economic actors, i.e., businesses as well as consumers. That is, even though American consumers are sending stress signals in responding to confidence and sentiment surveys, they have been preparing for battle any way, sort to speak, by buying all of those goods they can buy ahead of the increase in the price due to the effects of the tariffs. This was not reflected during the first quarter of the year, as real personal consumption expenditures (PCE) grew by only 1.8%, but it did happen during the fourth quarter of last year. PCE grew at a strong 4.0% rate during the last quarter of last year, with durable goods consumption growing at a strong 6.2% rate, motorized by purchases of motor vehicles and parts. This component of PCE grew by an impressive 19.7% during the last quarter of last year while falling by 11.1% during the first quarter of this year, quarter-over-quarter, annualized.

Of course, this is not something everybody can do at any point in time. Although firms front loaded imports during the first quarter of the year, as shown in the real GDP report released at the end of April, and consumers did so during the last quarters of last year, only those consumers at the higher income levels and/or those with access to credit could change their behavior, especially for the consumption of durable goods like cars or other large items. Consumers that do not have the wherewithal to do this will probably have to postpone consumption of some of these big ticket items.

For the economy as a whole, the tariff shock is an event that distorts normal behavior in the economy. That is, the front loading of imports during the first quarter of the year and the step up in auto purchases and other durable goods purchases during the fourth quarter of last year changes the typical behavior of economic actors and can put pressure on economic growth during the rest of the year. This is the reason why we have a relatively stronger second quarter of the year and then a weakening of economic activity in the following quarters.

This is also the reason why the Fed has chosen a policy path of “wait and see” because they still don’t know potential effects on inflation and the overall economy. For now, they said this week that the risks for employment and inflation have increased but will not commit to acting until they have a better sense of the actual impact. That is, the Fed is not going to reduce the federal funds rate at a time when inflation expectations are on the move, and everybody is expecting the rate of inflation to start to move higher. However, if the employment situation starts to deteriorate more than what we are expecting today, then the Fed will probably move and start lowering rates faster. But they are not going to move preemptively as they would have done if inflation had been a hovering about the 2.0% target for a long time, as it was the case for the period before the pandemic.

Changes to our forecast

At this time, we are estimating that the U.S. economy will avoid a “technical recession” but we are keeping our probability of recession at 50% just because it is difficult to know how the ongoing uncertainty about tariffs is going to evolve. At the same time, the acceleration of inflation will depend how high the tariffs are going to be, how efficient companies are at substituting away from Chinese goods, and when these price increases are going to appear in the statistics. For now, we expect inflation to start accelerating at the end of the first half of the year and during the second half of the year.

Thus, we are changing our estimate for the first rate cut from June to July, but are still leaving three rate cuts before the end of the year.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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