FOMC Update: Inflation Risks and Tariff Uncertainty in Focus

Markets expected the Fed to do nothing, and the Fed did not disappoint! Both the decision and the statement were a non-event. The FOMC kept Fed Funds in the 4.25-4.50% band. The statement itself was bland and diplomatic, acknowledging uncertainty. The one area of interest is that they spotlighted the dilemma between potentially higher unemployment and higher inflation, not just inflation. No update to the Summary of Economic Projections was scheduled for this meeting.

Indeed, the path forward is very uncertain. President Trump’s tariff announcements – and trading partner counter-reactions – have left markets reeling. Companies have been preparing contingency plans and pulling guidance this earnings season while awaiting further resolution. Markets have been searching for steady footing in very cloudy tariff negotiations. In the meantime, the economy is already slowing in reaction. The first quarter GDP release at the end of April confirmed a contraction in the U.S. economy. Survey data and high-frequency data (like container traffic) point in the same direction. Not only are tariffs dampening growth, but they will likely spark inflation. This creates a complicated environment for the Fed to navigate, and the Fed Chair Powell acknowledged this briefly in statements last month.

Given the turmoil, the Fed’s reaction function is hotly debated – when and how deeply they respond. Many observers – and even Fed Governor Waller – assess tariffs as having a one-time hit to inflation, arguing for more immediate cuts. However, the Fed’s post-pandemic misstep dismissing inflation as transitory and therefore keeping rates too low for too long casts a shadow on any current consideration to cut preemptively. Powell has emphasized that maintaining anchored inflation expectations underpins long-term inflation and growth. So, the consensus is that the Fed is unlikely to make such a move without more evidence. How much pain the economy must suffer for the Fed to waive off the inflation risk and pivot to supporting economic growth is contested. The Fed has claimed to be data-dependent, but in such a fast-moving situation, we’ll want to understand what soft and leading data they are weighing most in calibrating policy and move soon in June. And when they start to make a move, the cuts may have to run deep to catch up to slowing growth and stimulate consumption. After all, if higher rates didn’t hit consumers and companies that locked in favorable financing, then, in the opposite direction, it may require deeper cuts to stimulate debt-fueled demand.

During the press conference, Fed Chair Powell was balanced on where he sees risks. He made it clear that the Fed is unlikely to make any move without clarity on (1) tariff policy that allows for an assessment of the balance of risks and (2) hard data on the economy’s position. Powell thinks the cost of waiting is low, and making a false, premature move in one direction or another could be high. He backtracked to correct himself, indicating that rates could stay flat or get cut depending on how the economic picture evolves, so a scenario where the Fed increases rates is not top of mind.

Just as the statement was released, President Trump hit the tape saying he was unwilling to lower tariffs to get China to the table. The indication of an uncompromising position increases uncertainty, weighs on the economy, and tips the case for cutting rates sooner. The timing was interesting and arguably fed the reporters in the room with Powell some ammo to push him in a dovish direction. However, Powell stuck to the script.

The Fed has been very innovative in the last decade in expanding its role – tools, initiative, jawboning – from past norms. Powell emphasized that the Fed knows its role – a modest, circumscribed ambit. The attitude is that it’s a tricky situation, but not the Fed’s to solve. The initiative and remedy will come from Congress and the President.

One final beat: In light of Trump’s direct personal criticism and making a scapegoat of the Fed, Powell has been walking a fine line between asserting Fed independence and trying to avoid attracting further political heat.