Economic concerns are mounting, but the Fed isn’t cutting rates proactively

The Federal Reserve building in Washington, Nov. 3, 2024. The U.S. central bank is set to reinforce its wait-and-see approach at its meeting this week as President Trump’s tariffs begin to bite. (Anna Rose Layden/The New York Times)

By Colby Smith

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 Donald Trump called on Jerome 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 preemptively.

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 Trump, who on Sunday again criticized Powell while saying that he would not replace the chair before his term ends in May 2026.

“It’s too uncertain to be preemptive,” 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 Trump’s whipsawing plans for tariffs, tax cuts and other campaign promises.

The White House says trade deals will be worked out before 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 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.

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-19, 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 Trump’s tariffs, and ports along the coasts are already reporting a sharp drop in traffic.

In what he calls a “supply driven recession,” 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.