President Trump just made the job of the Federal Reserve that much more difficult as he unveiled the steepest tariffs in more than 100 years, taking markets by surprise.
Economists scrambled to revise their forecasts in ways that present twin challenges for the central bank: higher inflation and slower growth. Maybe, as some economists said, a US recession.
“The increased risks to both inflation and employment put the Fed in an even greater bind going forward,” Evercore ISI said in a Thursday note.
Traders reacted by boosting the number of interest rate cuts they expect to see from the central bank this year to four, as they bet recessionary worries will outweigh concerns about rising prices. They expect the first cut in June.
Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments
But other analysts were all over the map in their predictions for the Fed’s path.
Morgan Stanley said on Thursday it expects the Fed will not cut rates at all this year due to potential elevated inflation. Evercore said the likelihood of no cuts all the way up to more than five cuts in a recession are all roughly equal, although the firm’s base case is two to three.
Many Fed policymakers have emphasized in recent days that they want to keep rates where they are for some time as they digest the impact of Trump’s policies. Some said they are still worried about inflation and not sure if the impact on prices will be temporary or not.
Philip Jefferson, vice chair of the Federal Reserve, said Thursday there is “no need to be in a hurry” to make adjustments to rates.
Speaking in Atlanta, the Fed’s No. 2 official stressed that there are “significant changes” being made in trade, immigration, and fiscal policies and that “it will be crucial to evaluate the cumulative effect of these policy changes.”
If the economy remains strong and inflation doesn’t move down, he added, then the Fed could hold rates at the current level of 4.25%-4.5% for longer. If, however, the job market weakens or inflation falls then the Fed would react.
Fed vice chair Philip Jefferson, in 2023. REUTERS/Jonathan Ernst ·REUTERS / Reuters
Wilmington Trust bond portfolio trader Wilmer Stith said Thursday that the tariffs will keep the Fed in a wait-and-see mode.
“It just makes their job a little tougher, and do they sort of look through the probability that all of this hamstringing of corporate spending of uncertainty — it is going to metastasize into job cuts and negative economic growth down the road?” he said.
The biggest question is how long the tariffs actually stay on or if they can be removed soon by way of negotiation.
Luke Tilley, chief economist for Wilmington Trust, said the tariffs increase the odds of a US recession to 50% — and noted that a recession could develop if the duties are left in place for just three months.
“The more challenging thing is figuring out how much economic damage is coming from uncertainty for businesses and consumers,” he said.
More clues on where the Fed stands will emerge Friday, as Fed Chair Jerome Powell is scheduled to speak following the release of a jobs report for the month of March.
Powell said last month his “base case” is that any extra inflation from Trump’s slate of tariffs will be “transitory” — a view that aligns with the White House.
Benson Durham, head of global policy and asset allocation for Piper Sandler, said Powell can’t make much news Friday and that the Bank of Canada was spot on March 12 when it said that “monetary policy cannot offset the impacts of a trade war.”
He said the Fed is watching whether long-run inflation expectations remain moored. If investors “see through” the price effects of tariffs, then the Fed can, for now, preserve its base case of sauntering down to a “neutral” rate.
The Fed’s goal is to get inflation down to its 2% target, but a key measure released last Friday remains well above that marker. The “core” Personal Consumption Expenditures (PCE) index, which excludes volatile food and energy prices, rose 2.8% year over year.
Inflation now stands at the level the Fed predicted it would be at year’s end — and that’s before some of Trump’s most aggressive tariff plans kick in.
After Trump’s tariff announcement Wednesday, Fed watchers boosted their estimates of how much higher inflation could go.
Michael Feroli of JPMorgan Chase said in a note that the measures could boost PCE prices by 1-1.5% this year.
“The resulting hit to purchasing power could take real disposable personal income growth in 2Q-3Q into negative territory, and with it the risk that real consumer spending could also contract in those quarters,” he added in his note.
“This impact alone could take the economy perilously close to slipping into recession.”
The Fed’s Jefferson said while the economy is in a “solid position,” surveys of consumers and businesses show heightened uncertainty about the economic outlook.
It remains to be seen, he added, what these surveys imply about future spending and investment and the direction of the economy more broadly.
“If uncertainty persists or worsens, economic activity may be constrained,” he said.
U.S. Federal Reserve Chair Jerome Powell at a March 19 press conference in Washington. REUTERS/Nathan Howard ·REUTERS / Reuters
Click here for in-depth analysis of the latest stock market news and events moving stock prices
Read the latest financial and business news from Yahoo Finance
