Economic Developments - March 2025

Economic Growth Downgraded, Near Term-Inflation Revised Upward

We have revised downward our 2025 and 2026 growth outlooks from 2.2 percent for each year to 1.7 percent and 2.1 percent, respectively. This coincides with an upward revision to our inflation outlook for 2025, followed by a slight downward revision for 2026.

The major drivers of the changes to our economic outlook this month are:

• An updated assumption on tariffs to reflect current policy. Our previous forecast included the prior 10-percent China imports tariff increase, which went into effect last month. In our March outlook, we have included the since-implemented additional 10-percent tariff on imports from China (a total of 20 percent in total compared to tariff levels in 2024) and approximately half of the announced 25-percent tariffs on goods from Canada and Mexico, in line with the current implemented policy that exempts approximately half of goods currently subject to the United States-Mexico-Canada Agreement (USMCA).

• Weaker consumer spending. Real personal consumption expenditures fell 0.5 percent over the month, the largest decline since February 2021. While we had expected that consumer spending would downshift from the robust 4.2 percent annualized growth rate set in Q4 (as it had outpaced income growth), the January figure was weaker than we had expected. We think the sharp contraction in January spending data was likely overstated due to volatility around the holiday shopping season, California wildfires, and unusually cold and snowy weather in other parts of the country. As such, while we are downgrading our Q1 personal consumption forecast from 3.1 percent to 2.1 percent annualized, this is a less significant downgrade for the quarter than would otherwise be suggested by the January consumption data alone.
  
  Looking forward, we expect weaker wealth effect-driven consumption. While the recent pullback in equity prices as of this writing is not out of the ordinary, we believe continued resilience in consumer spending in 2024 was in part driven by strong stock market appreciation, leading to wealth effect-driven consumption gains, coinciding with a continued low personal savings rate. This tailwind for consumer spending is potentially no longer as strong. Consistent with this are weaker measures of consumer sentiment and recent comments during earnings reports from major retail and food service firms pointing to consumer softness. Taken together, we now expect a slower pace of consumer spending growth in coming quarters, as well as sluggish investment spending.

• Lower energy prices expected to partly offset the impact on inflation from higher tariffs. In the near term, lower energy prices that had been projected in our prior month’s forecast are expected to partially offset the near-term upward pressure to inflation measures related to tariffs. However, by the end of 2025, we expect the CPI to be at 3.2 percent before decelerating meaningfully in 2026 as the bump from tariffs passes.

In addition, we note that measures of uncertainty and market volatility have risen meaningfully this quarter. That greater uncertainty includes the likely path of fiscal, monetary and other policy developments, but also how firms and consumers respond to them and other financial market developments. There are plausible upside and downside risks to both growth and inflation measures over our forecast horizon, as well as to interest rates.

Modestly Lower Mortgage Rate Outlook

Coinciding with incoming economic data and policy changes, the yield on the 10-year Treasury note has pulled back into a range of 4.2 to 4.3 percent as of this writing, down about 25 basis points since our previous forecast. This has also translated into a modest downward revision to the 30-year fixed-rate mortgage outlook: We now expect rates to be around 6.3 percent at the end of 2025, down three-tenths from our prior forecast.

While the growth outlook has softened, we expect the upward pressure on price measures from tariff dynamics may lead to the Federal Reserve taking a wait-and-see approach as it seeks to balance its dual mandate for full employment and price stability. Federal Reserve Chair Jerome Powell recently stated that they “do not need to be in a hurry” to cut interest rates. As such, we project only one rate cut in September, followed by two additional cuts in 2026, though, again, there is both upside and downside risk here, too.

Housing Outlook Remains Little Changed, for Now

Historically, interest rate effects tend to be the dominant factor in driving home sales fluctuations compared to economic growth. Aside from credit crunch events, such as the Great Financial Crisis, home sales typically start rising – even amid economic contraction and weakening employment – if mortgage rates are falling. As such, we expect the modest pullback in mortgage rates to have a stronger positive effect to sales than the weakening of sentiment and a slower growth outlook. Therefore, combined with January existing home sales coming in near our expectations, we have slightly revised upward our existing home sales outlook for 2025 and 2026.

Regarding new home sales and construction, there is additional risk to starts stemming from upward pricing pressures related to tariffs on lumber and other materials. The National Association of Home Builders recently estimated the increased costs of lumber and other goods could raise the cost of constructing a typical home by about $10,000. However, lower mortgage rates would also give homebuilders some additional support by not having to offer as steep concessions and rate incentives to drive sales, and the net effect may be to keep homebuilders’ margins steady. As such, we have only made minor revisions to our new home sales and starts outlooks, largely reflecting incoming recent data.