President Trump's global trade war has greatly raised the Fed's bar for lowering interest rates as tariff risks worsen the already-knotted inflation problem while also hurting growth.
The message was driven by a speech by Fed Chairman Jerome H. Powell at the end of a turbulent week as financial markets melted after Mr. Trump’s tariff plan was revealed.
Powell warned Friday at an event in Arlington, Virginia that the measures would result in higher inflation and grow slower than initially expected. He expressed concern about the economic sourness, but his emphasis on the potential inflationary effects of the new tariffs suggests that it is an important source of anxiety.
“Our obligation is to maintain a good foundation for long-term inflation expectations and ensure a one-time increase in price levels does not become a persistent inflation problem,” Powell said. The Fed's mission includes two goals that promote a healthy labor market and maintain a low and stable inflation.
Before Mr. Trump returned to the White House, inflation had proven to be a stubborn stickiness, far exceeding the Fed's 2% target. However, the economy maintained great resilience, leading to a more gradual approach to lower interest rates, which ultimately led to a reduction in the suspension in January. At that policy meeting, Mr. Powell determined that the Fed needs to see “real progress in inflation, or some weakness in the labor market” to start cutting again.
But with inflation soaring due to tariffs, this will require obvious evidence that the economy is weakening significantly to get the central bank to move again. This could mean delaying the tax reduction until later this year or even next year, if the deterioration takes time to achieve.
“They don’t tend to lower interest rates to avoid possible recessions,” said Richard Clarida, former vice chairman of the Federal Reserve, who is now a global economic adviser to an investment firm, Pimco. “In fact, they will have to see the actual cracks in the labor market.”
Mr Clarida said he would look for a “material” rise in unemployment, or a “sharp slowdown, if not a contraction” in monthly employment growth, to illustrate what he expected would be higher inflation.
The latest work report released on Friday shows that the labor market is far from breaking down on the eve of Trump’s latest tariff blitz. Employers added 228,000 jobs in March, and the unemployment rate increased by 4.2% as labor market participation.
Worries about the economic outlook will soon outweigh any enthusiasm for the latest data – worrying Mr. Trump's top economic adviser seeks a settlement on Sunday.
Kevin Hassett, director of the White House National Economic Commission, acknowledged that the president's attitude could exacerbate inflation. “The price may increase,” he said in ABC's “This Week.” But he insists that Trump's plan will eventually reverse the long-term trend of importing low-cost products in exchange for unemployment.
“We bought cheap items at the grocery store, but then we had less work,” he said.
Treasury Secretary Scott Bessent also tried to downplay the prospects of the recession and told NBC on Sunday that there would be a “adjustment process.”
Economists across Wall Street are even more frustrated by the prospects. Many people, together with inflation forecasts, have dramatically increased the odds of recession. Those economists fear Mr. Trump’s tariffs are taxes on imports that will eventually cut consumer spending, squeeze corporate profit margins and potentially lead to layoffs, thereby increasing unemployment to more than 5%.
In that cohort, many expect the Fed to start rapidly reducing interest rates as early as June. The federal funds futures market reflects a more positive response, with five-point cuts this year.
Michael Feroli, chief economist at JP Morgan, called for a recession in the second half of this year, up 1% in the third quarter and down 0.5% in the fourth quarter. Over the year, he expects growth to grow by 0.3%, and the unemployment rate rises to 5.3%. Even as the Fed's preferred inflation scale (once volatile food and energy prices are revoked) soared to 4.4%, Mr Feroli predicts that the Fed will re-reduce the cuts in June and then lower borrowing costs at each meeting from January to January until the policy rate reaches 3%.
UBS chief economist Jonathan Pingle cuts a percentage point this year, even as core inflation reaches 4.6%. He expects the unemployment rate to peak at 5.3% in 2026. Goldman Sachs economists predict that the Fed will lay off three consecutive jobs starting in July.
But this prospect has credible risks. What prevails is that inflation shocks will be so big that the Fed has passed the situation before the summer, especially if the economy has not deteriorated in meaningful ways.
“The burden of proof is now higher because of the inflationary situation we are in,” said Seth Carpenter, a former Federal Reserve economist, who is now at Morgan Stanley. “They have to get enough information to convince them that the negative impact of slowing down (possibly negative) is greater than the cost of inflation.”
Mr. Carpenter said he does not expect to receive cuts from the Fed this year, but will reduce interest rates to 2.5% to 2.75% next year. Assuming there is no “mature” recession, economists at research firm LHMEYER have also put aside cuts this year.
Perhaps the most important determinant is when central banks will re-reduce interest rates reductions are the case with inflation expectations. Apart from some survey-based measures, expectations are expected to remain stable after the next year, and these measures are less reliable than others.
If these expectations start to swing in a more obvious way, the Fed will become hesitant and need to see a larger economic weakness than usual, said William English, a Yale professor and former director of the Fed's monetary affairs department.
Eric Winograd, an economist at the investment firm Alliancebernstein, said Mr. Powell's inflation-focused posture on Friday will help avoid the outcome. “The name of the game is: You talk hard,” he said. “Where you keep the expectations of inflation, and in doing so, you can retain the ability to relax later on when necessary.”
Mr. English said higher standards for lowering interest rates could make the Fed more difficult with the Trump administration. Until last week, the president had been under softer measures in criticism of the central bank, compared to his first term. He called for lower interest rates but tried to justify them by pointing out his plans to lower energy prices.
But as the rout in the financial markets intensified, Mr. Trump turned his anger toward Mr. Powell and the Federal Reserve. On Monday, Mr. Trump said the “slowly moving” Fed should lower interest rates. At one point, the president seemed to suggest that a market crash was part of his strategy. He circulated videos of users on Mr. Trump’s social media network that showed the president “deliberately collapsed” the market, partially forcing the Fed to lower interest rates.
The looming thing that the National Economic Commission’s Hassett raised on Sunday was, adding: “He is not trying to impress the market.”
Mr. Trump has tried to challenge the long-term independence of the central bank by targeting the Federal Reserve's oversight of Wall Street. His decision to fire two Democratic Commissioners last month also echoed widely, raising important questions about what kind of authority the president has over independent institutions and the people who run them.
During Friday's event, Mr. Powell said he fully intends to complete all terms within all terms ending in May 2026. He has also made it clear before that the president's early dismissal “is not allowed under law.”
“Now, the risk of Fed independence is greater,” said Mr. English, a professor at Yale University. “It's just keeping them on the shooting line.”
