If something is going to break in the U.S. economy, it will probably happen this summer, BofA Global says

Yahoo

25-06-2025

There are likely two distinct paths ahead for monetary policy in 2025, according to a pair of economists at BofA Global.
Assuming the labor market holds up, President Donald Trump's tariffs will likely cause enough inflation to prevent the Federal Reserve from cutting interest rates at all in 2025, the economists said. This is their base-case view for now.
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But if something is going to break in the economy, the BofA team reckoned it would probably happen before the end of the summer, which could lead to a dramatically different path for interest rates.
'We think the outlook is bimodal. If the labor market holds up as we expect, there will probably be enough tariff-driven inflation to prevent the Fed from cutting. But if something is going to break in the economy, we think it will happen over the summer,' BofA economists Aditya Bhave and Shruti Mishra said in a report shared with MarketWatch on Tuesday.
If the latter scenario comes to pass, they expect the Fed would quickly move to slash interest rates by 75 basis points beginning in September.
Investors who have been monitoring the Fed's evolving forecasts regarding the path of interest rates might recognize that the BofA economists' expectations don't exactly line up with what senior central bankers have penciled in.
As Bhave and Mishra pointed out, the latest batch of Fed forecasts, released last week, hinted that two distinct camps are forming within the Fed's policy-setting committee.
Nearly half of the members of the Federal Open Market Committee who contributed forecasts to the central bank's latest 'dot plot' expect the Fed will remain on hold at least until next year.
The other half expect at least two rate cuts in 2025, with the first likely coming in September. Fed governor Christopher Waller said late last week that the central bank could cut rates as soon as July. And on Monday, fellow governor Michelle Bowman said she would support a cut at the Fed's meeting next month.
According to the BofA Global team, the expectations reflected by the median dot, typically interpreted by markets and the financial press as the central bank's baseline forecast, seem unrealistic: Such a scenario would likely involve a 'Goldilocks' combination of tepid inflation and a labor market that is modestly cooling but not substantially weakening. On Wall Street, 'Goldilocks' is a byword used to describe an environment where inflation is low and the labor market remains mostly intact. The BofA team just doesn't see this as very likely.
The median dot's track record for accurately predicting the path of interest rates has been somewhat spotty, according to the BofA economists. They looked at how well the Fed's previous June projections have predicted rate moves later in the same year.
'At the June meetings in 2019, 2022 and 2024, not even one FOMC participant correctly forecast the change in policy over the rest of the year. The dots were more useful in other years, but forecasting is just very difficult in periods of elevated economic uncertainty,' they wrote.
A hazy outlook for the economy and the labor market makes predictions especially challenging, the BofA team said.
Fed Chair Jerome Powell reiterated during congressional testimony on Tuesday that he expects the central bank will remain on hold until more clarity emerges regarding how Trump's tariffs might impact inflation.
Other economists have warned that a weakening labor market could create problems for the economy in the months ahead if the Fed waits too long to cut rates.
'Right now, the FOMC does not appear to be especially concerned about the labor market but [is] quite concerned about the outlook for consumer prices. I take the opposite view, with heightened concern about the labor market,' said Neil Dutta, an economist at Renaissance Macro.
Dutta also saw signs that business investment remained sluggish, excluding spending related to artificial intelligence.
So far, U.S. stocks haven't exhibited signs of much strain despite some softness in the labor market, including a recent uptick in weekly jobless claims. The S&P 500 SPX was recently trading at 6,077, up 0.9% on the day. This puts the index within striking distance of its record closing high from February.
The Nasdaq Composite COMP and Dow Jones Industrial Average DJIA were also trading higher on Tuesday.
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