Less than a year ago, the Federal Reserve took decisive action to bolster the U.S. economy. With inflation easing and the labor market starting to soften, the central bank opted to go big, lowering interest rates by half a percentage point and signaling further cuts to come.
Rather than a panicky response to a crisis situation, the decision amounted to the Fed taking out some insurance to protect the labor market from weakening too much.
In a barrage of attacks on the central bank recently, President Trump called on Jerome H. Powell, the chair, to lower borrowing costs in a similar fashion to prevent the economy from slowing down. But the Fed no longer has the flexibility to move pre-emptively.
Mr. Trump’s tariffs and the inflation spike they could potentially unleash have left officials much more cautious about restarting interest rate cuts despite rising risks of an economic slowdown. The Fed is widely expected to keep interest rates steady when officials gather this week, extending a pause that began in January after a series of cuts last year.
But forecasts for when the Fed will have the confidence to cut again are in a constant state of flux, injecting yet more volatility into an already tenuous moment for the economy and the global financial system. Officials will need to see tangible evidence that the labor market is starting to weaken and people are struggling to find work before taking action. If it takes time to materialize, the Fed could be on hold for even longer than expected.
That risks keeping tensions simmering with Mr. Trump, who on Sunday again criticized Mr. Powell while saying that he would not replace the chair before his term ends in May 2026.
“It’s too uncertain to be pre-emptive,” said Ellen Meade, who served as a senior adviser to the Fed’s board of governors until 2021 and is now at Duke University. “The date for a cut is the time that the slowing of the economy outweighs, in their view, the overshoot in inflation.”
Policy Backdrop in Flux
Making a big policy pivot is never an easy judgment call, but the current circumstances have made it uniquely fraught. The Fed is having to contend with an ever-changing backdrop amid Mr. Trump’s whipsawing plans for tariffs, tax cuts and other campaign promises.
The White House says trade deals will be worked out ahead of a self-imposed 90-day delay to large levies initially announced in early April. But no one knows for sure how those are progressing, or even if the administration is in communication with one of its biggest trading partners, China. It is not yet clear what will happen after the July deadline lapses if deals are not reached. The administration has also set a July 4 goal to fulfill Mr. Trump’s promise to enact sweeping tax cuts, but the contours of that bill are still being worked out.
The uncertainty alone has already chilled business activity, causing paralysis in many industries as companies put off big investments and hiring until they get clearer direction from the White House. As recession odds have crept up alongside expectations about inflation in the year ahead, consumer sentiment has plummeted. Already, many consumer-oriented brands, from Chipotle to PepsiCo and Procter & Gamble, have reported sluggish sales.
When confronted with similar harbingers of an economic slowdown after Mr. Trump started a tit-for-trade war with China during his first term, the Fed opted to take action. It lowered interest rates three times in 2019, keeping a record expansion chugging along as price pressures stayed subdued.
But the Fed does not have the “luxury of 2019,” said Esther George, who retired as president of the Federal Reserve Bank of Kansas City in 2023. In Trump’s first term, the tariffs were much smaller in scale and inflation was consistently below the Fed’s 2 percent target. “In that world, you would probably see the Fed leaning in harder to a more proactive stance. I don’t think they can afford to do that right now.”
More Than Just Temporary?
Consumers are still grappling with the fallout of the worst inflation shock in four decades that hit after the pandemic. Price pressures have eased significantly since peaking in 2022, but have not been snuffed out entirely.
Tariffs, which are a tax on imports, are widely expected to reignite them. The question is by what magnitude and for how long. In theory, tariffs should only lead to a short-term increase that fades over time. But that is by no means assured in an environment in which consumers are already jittery about inflation.
“Inflation is as much a psychology as it is a measurement that you can really pinpoint,” Ms. George said.
The Fed pays closest attention to longer run measures of inflation expectations, especially those based on the U.S. government bond market. For now, they suggest a temporary burst in inflation that ultimately fades.
Proponents of this view argue that tariffs will indeed raise prices, but those increases will not persist because there are few forces to keep it going. Unlike the post-pandemic period, the labor market has significantly less momentum, consumers are in worse shape financially and the government does not appear ready to ride to the rescue again with generous stimulus measures.
Christopher J. Waller, a Fed governor, recently argued that tariff-induced inflation will be temporary. Yet even he has acknowledged that looking past this surge will not be easy. “It’s going to take some courage to stare down these tariff increases in prices with the belief that they are transitory,” he said in an interview last month.
Many economists warn that dismissing tariff-related price increases altogether would not be prudent either.
Jean Boivin, the former deputy governor at the Bank of Canada who is now head of the BlackRock Investment Institute, expects tariffs to induce a supply shock similar to what happened during Covid, when empty shelves led to higher prices and, in turn, persistently higher inflation. Businesses and consumers have already pulled forward purchases in an attempt to get ahead of Mr. Trump’s tariffs, and ports along the coasts are already reporting a sharp drop in traffic.
In what he calls a “supply driven recession,” Mr. Boivin forecasts that consumers will still want to spend but shortages will make that harder to do. When products do become available, consumers will be willing to pay the higher prices, translating to higher inflation that lingers for longer than it otherwise would have even as spending on the whole falls.
“It does raise a question about what the right medicine is,” said Raghuram Rajan, a former governor of the Reserve Bank of India, of the potential unintended consequences if the Fed lowers interest rates as shortages hit.
“Having demand pick up once again while supply is hugely constrained by these high tariffs may not be the best answer,” he said.
Layoffs Looming
The health of the labor market has taken on new significance against this backdrop.
So far it appears to be holding up, according to the latest jobs report released on Friday, which showed the unemployment rate steady at 4.2 percent. But economists do not expect that resilience to last. Layoffs are still low, but employers are posting fewer vacancies, hiring has slowed and wage growth has stalled, undeniable signs of softening.
Because the Fed sees little urgency to lower interest rates until there are clearer signs that the labor market is in jeopardy, a June cut looks increasingly improbable. Traders in federal funds futures markets now wager the Fed will reduce rates in July and deliver around four quarter-point cuts this year. But it is easy to see how the timing could be pushed back even further given expectations that the economic data will not deteriorate in a more noticeable way until July at the earliest.
James Knightley, the chief international economist at ING, now sees even odds that the Fed will restart rate cuts in July with a quarter-point reduction or move aggressively by half a percentage point in September. The longer the Fed waits, the higher the chances that it will need to provide more relief faster to contain the economic fallout.
“The Fed is equally at the mercy of the administration’s policies as everybody else. And with volatile policies, it is hard to anticipate what they will be and then react accordingly,” said Mr. Rajan, who is now at the University of Chicago Booth School of Business.
“It may well be that both the Fed and the administration move in the same direction if and when they see tremendous damage done, but evidence of the damage is needed for them to move.”
