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The U.S. Federal Reserve says “thank you for calling, please hold” as it keeps policy rates unchanged and makes almost no adjustments to its recent narrative that inflation and the labour market are back to appropriate levels.

Unlike the Bank of Canada’s rate cut just mere hours earlier, which was almost uniquely focused on trade conflicts, the U.S. central bank seemed to almost go out of its way to avoid mentioning any potential (however probable) policy changes from Washington D.C.

The Fed’s emphasis is instead that starting places matter and the U.S. economy is in “a really good place”. The Fed has done its job, certainly enough for a pause at this meeting and likely several more to come, in our opinion. Hauntingly, however, mid-way through his Press Conference, Chair Jerome Powell noted that “it is human nature to underestimate how fat the tails are in an economy… things can happen way out of your expectations.” Indeed, while this meeting (and recent data) offered a moment of pause to reflect on the progress made, it is likely a calm before a more complicated central bank forecasting storm ahead.

From the totality of today’s communication, we keyed in on 3 themes that will likely continue to weigh on the Fed narrative ahead.

1. The Fed’s focus is shifting back to the inflation side of its dual mandate

The only material changes to the Federal Reserve’s statement were (1) an ‘upgrading’ of its assessment of the labor market to simply “solid” and (2) perhaps more glaring, a removal of the reference of “progress” toward the 2 percent inflation target to a simpler and unqualified “inflation remains somewhat elevated.” While Powell subsequently referred to this as simply a “language cleanup”, we weren’t convinced that they are confident in their inflation forecasts for 2025: “… if you look at the sort of inner meaning data was good, and there was another inflation reading just before December meeting, so we got two good readings in a row consistent with 2% inflation.” That sounds like more than a language clean-up to us and instead a leaning into more concern about the inflation picture (rising).

On the inflation outlook, Powell has some right to be relieved: we agree that housing-related inflation should continue to come down fairly steadily in the months ahead. But our work suggests that that that downward trend reverses in H2. And if the labor market remains tight, as we expect, inflationary pressures from wages that bleed into broader services activity could also become a “sticky” situation for the Fed. To see continued weakness in inflation, the U.S. needs goods deflation… and, in general, tariffs don’t produce goods deflation.

That inflation backdrop – sticky above 2% with upside risks – sets the Fed up for a prolonged pause, in our view. Powell also seemed content with current policy: “We see things as in a really good place for policy, and for the economy. So, we feel like we don’t need to be in a hurry to make any adjustments” In fact, Powell went on to say, “If the economy remains strong and inflation does not continue to move sustainably toward 2%, we can maintain policy restraint for longer.”

2. Data dependence still rules the Fed’s next move… And we think is consistent with a further pause.

Indeed, it is clear the Fed will remain data dependent in 2025. When asked about how the Fed is thinking about its policy path ahead: “We are looking at the data to guide us in what we should do” and, when asked about how the Fed would incorporate new federal policies, Powell said: “ We study the data, we analyze how it will affect the outlook, and the balance of risks, and we use our tools to try to give it our best understanding, our best thinking to try to achieve our goals.” Data dependence has its benefits, particularly when the outlook is unclear. But it also creates uncertainty in the market about the Fed’s decision-making function and can lead to large volatility around data releases.

We have a good amount of conviction in our own outlook over the next few months: we expect the unemployment rate to remain low into the second quarter, and for inflation to be sticky. But there will be noise – impacts from the California fires may slow payroll growth, seasonal quirks may push up the pace of inflation, and threats of tariffs may skew trade data. Taken together, we think it will be hard for the Fed to get a clean reading on the economic data in Q1. These factors will likely prevent the Fed from gaining the confidence they need to resume cutting, especially with the heightened uncertainty surrounding the Trump administration policies. After all, Powell himself said “I think the range of possibilities is very, very wide. We just don’t know. I don’t want to start speculating.”

In other words, “Data dependence” probably translates to a Fed that doesn’t have the right data, or enough clarity in the data to cut again for the foreseeable future.

3. What wasn’t said might turn out to be more important for the Federal Reserve in 2025.

The Fed and Chair Powell’s prepared comments made no mention of any potential U.S. government policies including on tariffs, immigration or tax cuts. As he likely expected (evidenced by a prepared text he read off when pressed), Powell sternly batted away questions from the press about U.S. President Donald Trump’s potential policies. “We are looking to align our policies to executive orders,” he said. “I’m not going to have anything more specific for you on this set of issues.”

The implied protest was reminiscent of November’s comment from Powell that “we don’t guess, we don’t speculate and we don’t assume.” That works in theory, but the growing probability of proposed policies suggest that conviction in anyone’s baseline – economist or central banker – has to fall. In our view, American tariffs will create more upside risk for (or actual increases in) U.S. inflation and potentially, in the short term, weigh on growth. Deportations will tighten the labor market and keep pressure on wages, also an upside risk for inflation. While the magnitudes of the impacts will depend on the details of the policy, they mostly directionally point to higher supply-side inflation and, importantly, inflation that is not particularly interest rate sensitive. Perhaps the biggest challenge for the Fed won’t be in adjusting its forecasts, but in figuring out what the role of the central bank will be in that environment.

Regardless, this may be the last meeting where Chair Powell can avoid integrating the disruption that a variety of proposed policies will likely have on existing forecasts – in either direction. That is likely as unsettling for them as it is for markets, who will continue to be at the mercy of a shifting economic landscape over the next year.

Frances Donald is the Chief Economist at RBC and oversees a team of leading professionals, who deliver economic analyses and insights to inform RBC clients around the globe. Frances is a key expert on economic issues and is highly sought after by clients, government leaders, policy makers, and media in the U.S. and Canada.

Mike Reid is responsible for generating RBC’s U.S. economic outlook, providing commentary on macro indicators, and producing written analysis around the economic backdrop.

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