U.S. policy uncertainty roiling global financial markets and likely extracting a price on business capital expenditures and hiring creates a dilemma for the Federal Reserve: Tariffs raise the cost of imported goods, pushing up inflation, slowing economic growth and creating the conditions for rising unemployment.
These dynamics place pressure on both sides of the Fed’s dual mandate to establish maximum sustainable employment and obtain price stability.
In addition, as growth slows and prices rise, the conditions for stagflation coalesce, which results in a Fed frozen in the shining light of rising trade taxes and policy uncertainty. The reality is that central banks cannot do anything about tariffs.
That is why we do not expect the Fed to do anything on rates—hikes or cuts—until the second half of the year.
While we still forecast two rate cuts in the second half of the year, we are aware of the risks that the haphazard imposition of tariffs are placing on the economy.
Whatever damage tariffs do to firms—tariffs ultimately compress margins—and to households—almost all of the costs of the 2018 trade spat were passed along to consumers; the central bank is not in a position to act until there is a clear policy rationale.
When the Fed meets on March 18, it is likely that investors and firm managers will find out that they will have to wait until the new rules of the road on trade are established to see if the Fed leans toward price stability or is comfortable enough to cut rates as it looks through what will be a year of rising prices.
We expect the Fed to keep its policy rate in a range between 4.25% and 4.5% while adjusting its Summary of Economic Projections to anticipate slower growth at or near 2%.
The Fed is unlikely to change its unemployment forecast of 4.3% for this year, which in our view is consistent with full employment despite a softening in hiring.
The Fed’s interest rate forecast, or its dot plot, will remain unchanged, showing two 25 basis point cuts this year.
The Fed’s interest rate forecast, or its dot plot, will remain unchanged, showing two 25 basis point cuts this year, which will most likely dampen market expectations of three rate cuts that are currently being priced in.
Because of inflation remaining at least 50 basis points above target, policymakers are well aware of the importance of keeping inflation expectations well anchored amid what will be a volatile financial market environment.
I anticipate that the Fed’s policy statement will include an update to the language in the text around moderating growth and labor demand. The Federal Open Market Committee will restate that risks to its employment and inflation objectives are roughly in balance. Beyond that, there should be little change to the policy statement.
I do expect that Fed Chair Jerome Powell will provide a dovish coloring to his news conference over the policy uncertainty that is providing downside risk to growth and employment.
The primary dealer community will remain on edge around any announcement on changes to the Fed’s balance sheet runoff. While there will be a discussion on that subject, we do not expect any changes until the May 7 meeting at the earliest around any potential end to quantitative tightening.
