Tierney L. Cross / Bloomberg via Getty Images
-
The Federal Reserve is widely expected to hold its key interest rate steady when it meets Wednesday, but it’s up in the air whether it will cut interest rates later in the year.
-
The Fed may be forced to bail out the economy by lowering interest rates if President Donald Trump’s tariffs tank the job market.
-
The central bank could also decide to keep interest rates higher for longer to fight inflation if tariffs push up prices too much.
-
The Fed may face a dilemma of higher inflation and rising unemployment, forcing it to choose which problem to tackle with its monetary policy.
The Fed’s monetary policy decision Wednesday will take place amid massive uncertainty, which surged to an all-time high ahead of President Donald Trump’s “Liberation Day” tariffs.
Uncertainty about the Federal Reserve’s future actions rose to its highest level since at least 1985, according to this week’s reading of the Baker-Bloom-Davis index of monetary policy uncertainty. The index reflects March information and measures uncertainty by counting newspaper articles with specific keywords.
Although the Federal Reserve is widely expected to hold its key interest rate steady at its meeting on Wednesday, what happens after that is much more up in the air. The record-high uncertainty highlighted the Fed’s challenge: it doesn’t know exactly how the economy will react to Trump’s unprecedented trade wars.
The Federal Reserve has been holding its interest rate at an elevated level since January, keeping borrowing costs relatively high in order to discourage borrowing and spending and push inflation down.
Trump’s tariffs have shaken the outlook and put the Fed on uneasy footing. A major unknown is whether and how soon the Trump administration will strike deals with U.S. trading partners to remove or lower tariffs.
In the meantime, economists expect Trump’s tariffs—including a 10% global import tax on U.S. trading partners and duties as high as 145% on Chinese products—to push up the cost of living, which would be a setback in the battle against inflation. In response to surging inflation, the Fed could keep its benchmark fed funds rate high or even raise it, pushing up borrowing costs on all kinds of loans.
However, the tariffs may also damage the economy by costing jobs or even causing a recession. That would require the opposite response: lowering interest rates to give businesses and consumers easy money, giving a boost to the struggling economy and encouraging job growth.
Since the Fed can’t do both at the same time, it would have to choose which to prioritize. Financial markets are currently betting the Fed will be forced to rescue the economy as the job market weakens, and will start cutting interest rates in July according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.
But the economy is entering uncharted territory with Trump’s tariffs, and for now, the Fed is widely expected to wait for more clarity about the economy’s trajectory before acting. If a tariff shock to the job market is on the way, it didn’t show up in April, when employers added 177,00 jobs. That may encourage the Fed to hold steady for longer.
