Monthly Economic Outlook – February 2025

[00:00:00] Speaker 1: Welcome to the Wells Fargo Monthly Economic Outlook. I'm Charlie Dougherty, and joining me today to discuss how the latest developments are impacting the economy is my colleague, Sarah House. So Sarah, as we step further into 2025 here, many of the Trump administration's new economic policies are starting to take shape. Tariffs are front and center. So how are we incorporating tariffs into our economic outlook? Right. So we've been assuming that we'd see a big [00:00:37] Speaker 2: step in the use of tariffs in terms of this Trump administration since the election in November. So we were assuming that roughly half of the 60% tariffs on China that were talked about on the campaign trail, as well as about half of that 10% universal tariff would go into effect, just under the assumption that tariffs are a favored policy tool of President Trump. And so we would see more. So now that we're a few weeks into this new administration, we're starting to see that trade policy takes shape a little bit more. And we've already seen another 10% tariffs on China. It looks like there's a possibility of more. And so what we've done is we've pulled forward those expectations of tariffs on China. So specifically, we're now looking for 25% tariffs for Q2 on Chinese goods, and then probably an additional 5% in terms of tariffs on other products in Q3. So similar to what we had in our prior forecast. Now, there's still a lot of uncertainty around this, but we do think that this will have an effect on inflation. So when we look at the inflation forecast for the, for this year, we're expecting core CPI, for example, to stay a little bit above 3%. So roughly where we saw it in, in January and for the core PC deflator to continue to run about two and a half to 3%. So a little bit earlier inflation in this forecast before we start to see inflation cool off a little bit more in 2026. But of course, tariffs don't just affect prices. They can also impact growth. So Charlie, let me turn it back to you. What are we thinking about in terms of growth in light of the recent activity that we've seen, but also some of these tariff assumptions that we have in our forecast? [00:02:25] Speaker 1: Yeah. So currently the economy looks like it's in a pretty good place. I think the best indicator of that is that you're still seeing a steady pace of job growth and low unemployment. Take January's employment report, for example. We added 143,000 net new jobs and the unemployment rate fell to 4%, which is actually an eight month low. So overall, you're seeing a softer labor market, but it's performing reasonably well and supporting overall growth. So in terms of real GDP, we're tracking growth to be around 3% for the first quarter of the year, which would mark a modest acceleration actually from the fourth quarter of last year. So what's driving that? Well, you are seeing some inventory building, which is perhaps in response to the tariffs, but also you're seeing a still strong consumer sector. So one important thing I think to note here is that we are anticipating a growth slowdown over the next few quarters. And tariffs are part of that story. So if tariffs boost inflation, that could erode purchasing power that could weigh on consumer spending and overall create a more moderate pace of economic growth. Now, if you go further out into 2026, then you're likely to see some of the growth enhancing effects of things like a looser regulatory environment and lower tax rates. But over the next few quarters, you can anticipate a modest slowdown in terms of overall growth. So Sarah, if you're the Federal Reserve, how do you deal with this backdrop of a slower economic trajectory and [00:04:04] Speaker 2: still stubborn inflation pressures? So we've already seen the Fed cut a hundred basis point from the peak policy rate this cycle and see we've seen policy is no longer nearly as restrictive as what it was about six months ago. But now that we're in this period of some of that sturdiness in the labor market that you mentioned, the fact that we've had continued strength in inflation, including the January CPI data, the Fed, we think, is on a prolonged hold for the time period period. Now, we still think that we could see some cuts later this year. So our baseline remains that we'll see 25 basis point cuts at both the September and December meetings with this assumption that we do see growth slow and we see the unemployment rate creep up a little bit. So the Fed gives a little bit more of a nod to the employment side of its mandate as long as we're seeing inflation expectations stay anchored. But even if we were to see that additional 50 basis points of easing later this year, that would still keep the Fed funds rate at a range of 3.75 to 4 percent. So still notably higher than than what we saw last cycle and even a little bit above where Fed officials think policy would would be would be neutral. So still, in other words, a restrictive stance of policy. So, Charlie, what would this mean to some of the more rate sensitive sectors of the economy like housing and non-residential construction? [00:05:25] Speaker 1: Yeah. So if you take a step back, the effects of tight monetary policy have been very evident in the construction sector. So specifically, if you look at multifamily development or commercial real estate development in general, you've seen a sharp contraction in activity as the Fed has increased interest rates. So if interest rates do come down a little bit more, that'll help support overall activity. But you're still looking at a high level of interest rates, which I think will be a constraint on growth moving forward and for the construction industry. Now, on top of that, you have an additional headwind that could be coming in terms of these changing economic policies. So the construction industry is highly exposed to tariffs, right, because a lot of building materials like steel and aluminum are imported from abroad. On top of that, the construction labor force is highly dependent on foreign-born workers. So if you do see tighter immigration policy, that could weigh on construction labor force growth and overall present a challenging environment for the construction industry moving forward. [00:06:34] Speaker 2: Well, good talking to you, Charlie. And from all of us at Wells Fargo, thanks for joining us on our latest monthly economic outlook.