While another interest rate pause looks like a foregone conclusion at this week’s Federal Reserve policy-setting meeting, the path forward is anybody’s guess. In the bond market, traders are betting that the Fed will lower interest rates in July. However, given the significant unknowns in the economic outlook resulting from President Donald Trump’s trade wars, the timing of interest rate cuts (if there are any this year at all) could change dramatically in the months ahead.
It’s an extremely unusual moment for the US and global economy. Since Fed officials last convened, there’s been a seismic shift in the outlook. Markets shuddered after Trump announced sweeping “reciprocal” tariffs on US trading partners on April 2. Economists generally agree that tariffs will impact the economy, though the scale of these effects will heavily depend on whether the announced rates are reduced. But forecasters say that even lower tariffs than what Trump has threatened will slow growth and raise inflation.
Such impacts will come as growth was already set to slow in the years after the pandemic rebound. But unlike during during the pandemic, analysts don’t expect the Fed to rush to slash rates. Inflation is higher than central bankers would like, and the impact of the tariffs is still highly uncertain, with trade negotiations ongoing and a 90-day pause on many levies still in effect.
So far, there has been little visible impact in the official government data, although figures on first-quarter gross domestic product growth showed the impact of companies rushing to import goods ahead of expected levies. While that sort of “hard” economic data has yet to reflect the direct impact of tariffs, “soft” data (such as consumer and business sentiment) has deteriorated sharply. That leaves the Fed in “wait and see” mode, with asset prices and investor expectations for monetary policy churning higher and lower on a daily basis in the absence of concrete information about the outlook.
The Fed Continues its Balancing Act
Markets celebrated a benign jobs report on Friday, which analysts said was a sign that Trump’s radical overhaul of US trade policy hasn’t yet dented the labor market. Strategists say that report will likely give central bankers the confidence to hold rates steady for another month. But in the months ahead, Fed officials will have to balance the twin risks of higher inflation and slowing growth—a tricky proposition.
“This is a very tough spot, because you’re seeing a stagflationary shock with the tariffs,” says Don Rissmiller, chief economist at Strategas. Tariffs will put upward pressure on prices, while the labor market is at risk as the economy slows. “That’s a problem for both mandates,” Rissmiller says. The Fed wants low and stable inflation alongside maximum employment. Higher inflation generally warrants tighter monetary policy to help slow the economy, while a slowing economy and a cooling labor market would call for lower interest rates and more stimulative policy.
Right now, it’s not clear which side of the dual mandate will deteriorate first, or how quickly. “How are they going to reconcile those things? The data is just not there yet, and so I think more time is warranted,” says Lindsay Rosner, head of multi-sector fixed-income investing at Goldman Sachs Asset Management. Rissmiller says inflation data tends to move more quickly than employment data, and it could show strain from tariffs earlier.
Uncertainty Remains High
Even as markets coalesce around expectations for three cuts for the remainder of the year, Rosner stresses that the range of potential outcomes remains wide. Policy surprises have upended market expectations this year, and markets still lack clarity on what tariffs will look like. “There are many paths this could all take,” she says. If inflation remains sticky while tariffs hurt growth less than expected, rates could stay steady for the rest of the year. But a trade war escalating and a recession emerging, prompting more aggressive rate cuts, is also on the table.
‘The idea that all of this is known and is going to be in this very clear, tight policy path—I think the market has moved on,” Rosner says.