The Fed’s Latest Economic Projections Underscore Economic Uncertainty

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

We’re starting the new week watching the news out of the Middle East. It may be days or weeks before it is fully known how successful Saturday’s efforts by the U.S. to knock out Iran’s nuclear program were. Similarly, it is too early to gauge how the latest development will affect diplomatic efforts between Israel and Iran. We believe the events over the weekend will have an impact on the markets. The price of oil may rise, and we would not be surprised to see investors moving money to perceived safe havens. The latest developments add yet another layer of uncertainty to an already uncertain economic backdrop and could act as a growing headwind, particularly if fighting ratchets up in response. We will be watching the situation and its potential impact on markets closely.

Stocks declined modestly last week as questions about potential trade deals and the fighting between Iran and Israel were left unanswered. With no news on tariffs and questions before investors became aware of the U.S. bombing of Iran nuclear sites on Saturday, many investors looked to the Federal Open Markets Committee (FOMC) to provide some insights about its members’ thinking and whether the Fed was likely to cut interest rates soon. Here, too, investors were likely left with more questions than answers despite the Fed releasing its updated Summary of Economic Projections (SEP), or so-called “dot plot.” The latest SEP showed that the FOMC as a whole expects two more rate cuts by the end of the year, unchanged from the projections released in March. However, the number of participants who expect no rate cuts this year nearly doubled from four to seven. The broad spectrum of views was also on display in public comments by members of the Fed following the latest meeting.

Federal Reserve Chair Powell noted during his press conference after last week’s FOMC meeting that the Fed believes the economy and job market are solid and that it has room to be patient as it waits for final trade agreements and their impacts to work their way through the economy. However, just days later, Fed Governor Christopher Waller said during an interview that cuts should come sooner than later. “I think we’ve got room to bring it [the Fed Fund’s rate] down, and then we can kind of see what happens with inflation,” Waller said during an interview with CNBC. Waller’s view is based on his belief that price increases tied to tariffs will be a one-off event and that after an initial step up in prices, inflation will return to its recent trend of easing.

To be sure, Waller’s view is just one of many at the Fed. Indeed, the latest SEP shows that the median forecast calls for the Personal Consumption Expenditures (PCE) index to rise to 3 percent by year-end, up from the March median projection of 2.7 percent. Similarly, projections for year-end core PCE have risen from 2.8 percent in March to 3.1 percent in the SEP released last week. At the same time, the latest projections estimate the unemployment rate will rise to 4.5 percent from its current level of 4.2 percent. Should these projections materialize, it would put the Fed’s dual mandate of full employment and price stability at odds. We highlight these varying opinions to illustrate the level of uncertainty that continues to cast a shadow on the markets and economy.

While we believe it is likely that tariffs will lead to price increases, it is impossible to predict with certainty how the burden from the new levies will be shouldered among suppliers, manufacturers and consumers. It is likely that each group will end up paying a portion of the tariffs. The way the added costs are divided among the groups will likely have a meaningful impact on the economy and markets going forward. Likewise, it is unclear how quickly tariffs will begin to be felt throughout the economy. As we’ve noted in recent weeks, hard economic data has been distorted by consumers and businesses altering their buying decisions in anticipation of tariffs. The result was a surge in demand before the tariffs were announced followed by a decline in economic activity after they were announced. With trade negotiations ongoing, it is possible that businesses and consumers are taking a wait-and-see approach to purchases and investments or perhaps basing decisions on what they think the likely outcome will be. Put simply, investors will likely need to wait to gauge the ultimate impact of not only tariffs but other aspects of the administration’s economic policies as well, including taxes and changes to the regulatory environment.

But while the magnitude of changes President Trump is pursuing is significantly larger than in recent memory, the playbook for the unpredictability in the economy and markets remains the same. While risks and uncertainty may be elevated, we do not believe they call for dramatic changes to your investment plan. Instead, the current environment serves as a valuable reminder that an unpredictable future will lead to unpredictable opportunities for investors in the intermediate and long terms. And capitalizing on these unforeseen opportunities is best done through diversification.

Conversely, investors who sell during periods of volatility help to create opportunities for extra returns for those who stay true to their asset allocation. While we believe uncertainty will remain elevated for a while, we also believe the best way to address it is by focusing on the long term and staying diversified to avoid concentrating too much on any one market segment or asset class.

Wall Street wrap

Manufacturing output edges higher: Manufacturing output rose by 0.1 percent in May after falling 0.5 percent in April, according to the latest data from the Federal Reserve. The increase was driven by a 0.4 percent rise in durable goods, with motor vehicle production and parts up 4.9 percent, while aerospace and miscellaneous transportation equipment production was up 1.1 percent. The rise in durable goods manufacturing may reflect companies trying to get ahead of tariffs during the “pause” on reciprocal tariffs that is set to expire July 9.

Overall, industrial production fell 0.2 percent in May and is down 1.5 percent on a three-month annualized basis and 0.6 percent on a year-over-year basis. Industrial production and capacity utilization for manufacturing continue to run below their long-term historical average. We will continue to monitor this, as excess capacity could eventually lead to softening of the employment picture.

Retail sales decline as consumers hunker down: The latest retail sales numbers from the U.S. Census Bureau show that consumer spending declined last month, with overall retail and food service sales falling 0.9 percent in May. The decline was sharper than Wall Street expectations and marked the second consecutive month of declining sales. April’s estimate was revised downward to a decline of 0.1 percent.

Overall, seven of the 13 categories declined in May’s report, led by a 3.5 percent drop in motor vehicle sales; sales at building material and garden equipment and supply stores fell 2.7 percent, and gas stations saw a drop of 2 percent. Overall retail sales are up 3 percent year over year on a seasonally adjusted basis. The slowdown in sales continues a trend that began last month of consumers reining in spending after buying ahead of expected price increases from proposed tariffs. Overall, the Control Group (which is a proxy for the spending measure found in gross domestic product growth) rose 0.4 percent for the month, above Wall Street expectations of a 0.3 percent increase and up from April’s decline of 0.1 percent.

Forward-looking indicators point to headwinds: The latest Leading Economic Indicators (LEI) report from the Conference Board weakened modestly, and the measure is now once again signaling and increased risk of a recession. The May LEI reading showed a decline of 0.1 percent after April’s final reading showed a decline of 1.4 percent. The reading is now down 5.2 percent on an annualized basis over the past six months, weaker than the six-month annualized decline of 4.5 percent reported in April. The six-month diffusion index (the measure of indicators showing improvement versus declines) faltered, registering 20 percent, well off last month’s 15 percent reading. Historically, when the six-month annualized LEI falls below –4.1 percent and the six-month diffusion index registers below 50, it indicates the economy is in or on the cusp of a recession. However, both criteria were met in 2024, leading many, including us, to expect a recession that never materialized. For the third consecutive month, a downturn in consumer expectations weighed most heavily. However, a rise in stock market performance helped offset some of the total weakness from the various indicators measured, followed by a decline in the stock market and weaker new orders for manufacturers. Despite the measure warning of a potential economic contraction, “the Conference Board does not anticipate recession, but we do expect a significant slowdown in economic growth in 2025 compared to 2024, with real GDP growing at 1.6 percent this year and persistent tariff effects potentially leading to further deceleration in 2026,” Justyna Zabinska-La Monica, senior manager, Business Cycle Indicators at the Conference Board, noted in remarks released with the report.

Jobless claims trend higher: The latest data from the Department of Labor shows that initial jobless claims were at 245,000, a decline of 5,000 from the previous week’s upwardly revised total. The four-week moving average of initial claims numbered 245,500, which was the highest reading since August 2023. Continuing jobless claims (those people remaining on unemployment benefits) stand at 1.945 million, down 6,000 from the previous week’s revised total. The four-week rolling average of continuing claims came in at 1.926 million, an increase of 13,000 from last week and also the most since late November 2021. As we’ve noted in prior commentaries, we believe continuing claims are a more reliable indicator of the labor market, as they measure workers who are facing long-term challenges in finding a job and, as such, filter out some of the temporary noise that can be found in initial claims data.

Homebuilders’ confidence remains underwater: Homebuilder confidence weakened in June as buyers remain concerned about tariffs and interest rates. The latest reading from the National Association of Home Builders (NAHB) survey shows confidence came in at 32 in June, down two points from May and now at the third lowest reading since 2012.

With potential buyers sitting on the sidelines waiting out economic uncertainty and hoping for lower rates, builders are turning to price reductions to attract sales traffic. The latest data shows 37 percent of builders cut prices in June, the highest percentage since the survey began tracking price cuts on a monthly basis in 2022. The latest reading is up three points from the previous month. The average price cut was 5 percent in June, the same level seen every month since November 2024. The use of sales incentives to entice buyers rose to 62 percent, up one point from May.

Housing starts decline: The latest housing starts data from the U.S. Census Bureau shows residential starts tumbled 9.8 percent in May to a seasonally adjusted annualized rate of 1.256 million. May’s seasonally adjusted pace is the lowest since May 2020. On a year-over-year basis, starts were down 4.6 percent. Single-family housing starts rose by 0.4 percent from April’s revised pace to a seasonally adjusted annualized rate of 924,000 units.

Total building permits decreased in May by 2 percent to 1.393 million. Single-family permits were down 2.7 percent from the prior month to 898,000. Multifamily permits came in at 444,000, an increase of 1.4 percent.

The week ahead

Monday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for June. Activity on the services and manufacturing sides of the economy quickened last month as both sides of the economy saw increased costs. We will be watching to see if ongoing uncertainty about tariffs has had an impact on recent trends for both sectors.

We’ll get insights into the housing market when the National Association of Realtors releases existing home sales for May. This report should give a clearer picture of whether the housing market is still stuck in a holding pattern due to elevated interest rates and home prices despite growing inventories.

Tuesday: The S&P CoreLogic Case-Shiller Index of property values covering April will be released. Prices overall have moved higher, albeit at a slower pace, in the past several months. We will be looking to see if home prices continue to rise.

Wednesday: The U.S. Census Bureau will release data on new home sales for May. This report, along with the existing home sales data, will provide a look at the health of the real estate sector.

Thursday: Data on durable goods orders for May will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of growing uncertainty and slowing economic growth.

Initial and continuing jobless claims will be out before the market opens. Initial and continuing claims have been rising of late, and we’ll continue to monitor this report for signs of changes in the strength of the employment picture.

Friday: The May Personal Consumption Expenditures Price Index from the Bureau of Economic Analysis will be out before the opening bell. This is the preferred measure of inflation used by the Federal Reserve when making interest rate decisions. We’ll be monitoring to see if the latest data shows additional signs of progress in the disinflation process or if tariffs are beginning to show up in inflation readings.

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