Bank of America: This year's U.S. interest rate policy may face two directions, depending on tariffs and employment

Bank of America economists stated that U.S. monetary policy may face two distinctly different paths in 2025, with the tariffs reimposed by the Trump administration becoming one of the key factors influencing the Federal Reserve's interest rate decisions.

According to the latest report obtained by Zhitong Finance APP, two economists from Bank of America Global Research, Aditya Bhave and Shruti Mishra, pointed out that if the labor market remains resilient, the inflationary pressures brought by Trump’s tariffs may prevent the Federal Reserve from cutting interest rates throughout 2025. This is also their current "baseline scenario" forecast.

However, they also warned that if the economy experiences a "breakdown," it is likely to occur before the end of this summer, at which point the Federal Reserve may take significant easing measures to address potential recession risks.

"We believe the outlook presents a bimodal distribution," the two economists wrote in a report sent to MarketWatch on Tuesday. "If the labor market remains robust as we expect, then tariff-driven inflation may be sufficient to prevent the Federal Reserve from cutting rates; but if economic problems arise, we believe they will occur in the summer, rather than later."

If the latter scenario comes true, they expect the Federal Reserve to cut rates by 75 basis points as early as September.

Bank of America's forecast shows a significant divergence from the interest rate outlook within the Federal Reserve. The latest "dot plot" released by the Federal Reserve last week indicated a clear division within the Federal Open Market Committee (FOMC): about half of the members expect to keep rates unchanged before 2025; the other half anticipate at least two rate cuts, with the first potentially occurring as early as September.

Federal Reserve Governor Waller stated last weekend that the Federal Reserve could cut rates as early as July, while another governor, Bowman, also expressed her willingness to support a rate cut next month.

However, Bank of America economists believe that the "median point" forecast widely interpreted by the market is unrealistic. This forecast scenario relies on a "Goldilocks" economic environment: moderate inflation, a slightly cooling labor market, but no substantial weakness. On Wall Street, "Goldilocks" is used to describe an ideal economic state that is neither too hot nor too cold, and Bank of America believes that this ideal combination is "extremely unlikely" to occur in reality.

Bank of America pointed out that the historical accuracy of the "median" forecast in the Federal Reserve's dot plot has not been ideal. For example, in the meetings of 2019, 2022, and June 2024, not a single FOMC member accurately predicted policy changes within the year. "The dot plot may have some reference value in other years, but predicting itself is very difficult during periods of high economic uncertainty," the two economists wrote in the report.

Federal Reserve Chairman Powell emphasized during his testimony in Congress on Tuesday that the Federal Reserve will continue to remain cautious as the impact of Trump’s tariffs on inflation remains unclear At the same time, some economists are concerned that if the Federal Reserve waits too long to cut interest rates, it may exacerbate labor market weakness and further drag down the overall economy. Neil Dutta, chief economist at Renaissance Macro, pointed out that the current FOMC "seems less worried about the labor market and is instead very sensitive to price prospects," while he himself holds the "opposite view," believing that the risks in the labor market are more worthy of caution.

Dutta also noted that, aside from the artificial intelligence-related sectors, corporate investment remains sluggish, which is a negative signal for economic vitality.

Despite signs of a softening labor market (such as a slight increase in weekly initial jobless claims), the U.S. stock market has not shown significant pressure. As of Tuesday, the S&P 500 index rose 1.11%, approaching the historical closing high set in February of this year. The Nasdaq Composite Index and the Dow Jones Industrial Average also rose 1.43% and 1.19%, respectively