President Trump’s World Trade War has significantly raised facilities for the Federal Reserve to cut interest rates. Tariffs risk damaging growth while exacerbating the already linked inflation problem.
Fed Chairman Jerome H. Powell returned the message home with a passionate and anticipated speech that came at the end of a turbulent week as financial markets melted after Trump’s tariff plans were revealed.
The measure will lead to higher inflation and slower growth than expected, Powell warned at an event held in Arlington, Virginia on Friday. He expressed concern about the outlook for a sour economy, but his emphasis on the potential inflationary effects of the new tariffs revealed that it is an important source of anxiety.
“Our duty is to fully secure long-term inflation expectations and ensure that one-time price levels rise does not become an ongoing inflation issue,” Powell said. The Fed’s mission includes two goals to foster a healthy labor market and maintain low and stable inflation.
Before Trump returned to the White House, inflation had already proven stubbornly sticky, far surpassing the Fed’s 2% target. However, the economy is remarkably resilient, leading central banks to adopt a more gradual approach to interest rate cuts that would suspend cuts in January. At that policy meeting, Powell established that the Fed needs to see “true progress in inflation, or weaknesses in the labour market.”
However, with inflation set to soar due to tariffs, concrete evidence is needed that the economy is weakening significantly to move the central bank back on. That could mean that if interest rate cuts are pushed out until the second half of this year or if it takes time for the worse to happen, it will be delayed until next year.
“They don’t tend to take the lead to cut fees to avoid a possible recession,” said Richard Clarida, former vice-chairman of the Fed, a global economic adviser to investment firm Pimco. “They’ll have to actually see the real cracks in the labour market.”
Clarida said he would seek to explain what he expected to expect to have high inflation, in search of a “material” rise in unemployment or a “very sharp, if not a contraction” in monthly job growth.
The latest employment report released Friday showed the labor market was far from cracking on the eve of Trump’s latest tariff blitz. The employer added 228,000 jobs in March, bringing the unemployment rate to up to 4.2% as labor market participation rose.
Enthusiasm for the latest data was quickly overtaken by a torrent of concern over the economic outlook.
Kevin Hassett, director of the White House National Economic Council, acknowledged that the president’s approach could exacerbate inflation. “Prices could rise somewhat,” he said on ABC’s “this week.” But he argued that Trump’s plans would ultimately reverse the long-term trend of importing low-cost products in exchange for unemployment.
“I got cheap products from the grocery store, but then I had less work,” he said.
Treasury Secretary Scott Bescent also tried to downplay the outlook for a recession, informing him on Sunday that there will be a “meet the media” and a “coordination process.”
Wall Street economists are far more gloomy about the outlook. Many have sharply raised the odds of the recession along with forecasting inflation. These economists fear that Trump’s tariffs, a tax on imports, could ultimately destroy consumer spending, squeeze profit margins for businesses and lead to layoffs over 5% of unemployment.
Many in this cohort hope that the Fed will quickly cut interest rates as a result, and it will begin as early as June. Federal Funds Futures Markets reflects an even more aggressive response, with a 5-point cut being sold this year.
Federal Reserve Chairman Jerome H. Powell said he intends to offer all terms that end in May 2026 at an event in Arlington, Virginia on Friday.
JP Morgan’s US Economics President Michael Ferroli is calling for a recession later this year, down 1% in the third quarter and another 0.5% in the fourth quarter. Over the year, he expects growth to drop by 0.3% and unemployment rates to rise to 5.3%. Even if the Fed’s preferred inflation gauge (after unstable food and energy prices have been peeled off) has skyrocketed to 4.4%, Feroli predicts the Fed will resume cutting in June and reduce borrowing costs until the policy rate reaches 3% at all meetings through January.
UBS chief economist Jonathan Pingle has set up his pencil at a percentage reduction this year, even if core inflation reaches 4.6%. He expects unemployment will shoot high this year before peaking at 5.3% in 2026. Goldman Sachs economists predicted the Fed would offer a quarter-point cut, three consecutive times since July.
However, there is a reliable risk to this outlook. What’s common is that the inflation shock is too big, especially if the Fed has seen it past it by summer, especially if the economy hasn’t yet deteriorated in a meaningful way.
“The current burden of proof is high due to the inflation situation we are in,” said Seth Carpenter, a former Fed economist who is currently at Morgan Stanley. “They need to have enough information to convince them that the negative effects of slowing down and perhaps the negative effects will outweigh the costs of inflation.”
Carpenter said there will be no cuts from the Fed this year, but he hopes for multiple cuts next year, cutting interest rates from 2.5% to 2.75%. Economists at research firm Lhmeyer are also shelved the cuts this year, assuming there is no “full” recession.
Perhaps the most important determinant of when central banks will resume rate cuts is what happens in inflation expectations. Over the next year, expectations are somewhat stable, except for some survey-based measures that are considered less reliable than others.
If these expectations start to wobble in a more remarkable way, the Fed should even hesitate to cut and see even more economic weakness than usual, said William English, Yale professor and former director of the Fed’s finance division.
Eric Winograd, an economist at investment firm Alliancebernstein, said Powell’s inflation-focused stance on Friday would help to avoid that outcome. “The names of the games are: You’ll talk tough,” he said. “You maintain your expectations of inflation where they are and by doing that, you maintain your ability to ease later when necessary.”
High standards for interest rate cuts could put the Fed in a more stringent place along with the Trump administration, according to English. Until last week, the president was more restrained in his criticism of the central bank compared to his first term. He wanted lower interest rates, but among other reasons he tried to justify them by pointing out his plan to lower energy prices.
But as financial market defeats escalated, Trump turned his anger towards Powell and the federal government. On Monday, Trump said the Fed should cut interest rates “moving slowly.” At one point, the president seemed to suggest that market defeat was part of his strategy. He distributed videos from users on Trump’s social media network, suggesting that the president would “deliberately crash” the market, forcing the Fed to lower the Fed.
Closer on the issue on Sunday, Hassett of the National Economic Council responded by saying the Fed is independent before adding that “he is not trying to compete with the market.”
Trump is already trying to cut down years of independence from the central bank’s White House by targeting the Fed’s Wall Street surveillance. His decision to fire two Democrats from the Federal Trade Commission last month also echoed widely, raising important questions about the president’s authority over independent agencies and the staff who run them.
At an event Friday, Powell said he intends to provide all terms that end in May 2026. He also made it clear that early removal by the president is “not permitted under the law.”
“The risks to the Fed’s independence are now growing,” said Professor Yale English. “It just puts them right on the shooting line.”
