In mid-June, the Federal Reserve released its latest economic outlook, sparking widespread debate about where the U.S. economy is headed. According to the new forecast, the U.S. is facing a tough combination of pressures—from trade tensions to stubborn inflation—and inside the Fed, opinions are diverging on how best to respond.
The central bank now projects U.S. GDP growth to slow to just 1.4% in 2025, a significant downgrade from the 1.7% forecast made in March. Growth expectations for 2026 and 2027 also remain tepid, at 1.6% and 1.8% respectively. Meanwhile, the unemployment rate is expected to rise to 4.5% in 2025, up from an earlier forecast of 4.2%, and could stay elevated for several years.
Inflation is also proving stickier than anticipated. The Fed now expects core PCE inflation—a key measure it tracks—to hit 3% next year, higher than the previous 2.7% estimate. This combination of slower growth and higher inflation raises the prospect of stagflation, a scenario that complicates the Fed’s ability to shift gears on policy.
One major factor driving this more cautious outlook is the latest round of tariffs from Washington. The Biden administration recently imposed new tariffs on imports from China and the EU. These measures, along with the risk of retaliatory actions from other countries, threaten to put additional pressure on manufacturing, consumer prices, and overall growth. Analysts estimate that the 2025 GDP growth rate could decline by up to 0.8 percentage points due to these trade policies, with the unemployment rate ticking up by 0.4 percentage points. Everyday items like clothing and footwear—heavily reliant on imports—could see sharp short-term price hikes, disproportionately affecting lower-income households.
These mounting challenges are also leading to disagreements within the Fed. Some policymakers favor a wait-and-see approach, holding off on changes until more data comes in. Others believe a more proactive monetary policy stance is needed to counter the uncertainties stemming from trade disruptions. The lack of consensus introduces a layer of unpredictability into the Fed’s future moves.
It’s not just the Fed that’s turning cautious. International bodies are following suit. The OECD recently downgraded its forecast for U.S. GDP growth in 2025 to 1.6%, and for 2026 to 1.5%—a stark contrast to the projected 2.8% growth rate for this year. The organization warned that recent shifts in trade policy are driving up business costs and slowing economic recovery. It also noted that global growth is likely to soften, with expectations for 2025 and 2026 now trimmed to 2.9%, down from 3.3% in 2024.
At present, the Fed is holding interest rates steady, keeping the federal funds rate between 4.25% and 4.5%, but has stressed that future decisions will be based on incoming economic and inflation data. Markets are increasingly pricing in the possibility of rate cuts later this year—potentially up to two by December—if economic momentum continues to slow or downside risks escalate.
Adding to the complexity is the upcoming U.S. presidential election, which could usher in significant policy changes. Both trade and monetary policy directions are now top concerns for businesses and investors alike. For investors on this side of the globe, now is a critical time to reassess asset allocation strategies in preparation for potential market volatility and policy shifts.
The direction of the U.S. economy isn’t just a Wall Street issue—it will have implications for global capital flows and risk sentiment around the world.
