US Federal Reserve Chairman Jerome Powell’s job is getting a lot more difficult.
Fed officials this week facing heightened uncertainty over the economic outlook, a surprise contraction in first-quarter growth, fragile long-run inflation expectations, slumping investor sentiment, financial market volatility and rising recession fears.
At the centre of this uncertainty are President Donald Trump's tariffs.
Since the Fed's March meeting, Mr Trump has unveiled an avalanche of tariff declarations, which reached its crescendo on April 2 with his universal and reciprocal charges.
Currently, the US is imposing a 10 per cent universal tariff on all countries plus sector-specific charges. The tariff rate on China – America's third-largest trading partner – is 145 per cent.
“It is now becoming clear that the tariff increases will be significantly larger than expected,” Mr Powell said during an event in Arlington, Virginia, last month. “The same is likely to be true of the economic effects,” he added, pointing to inflation and economic growth.
Still, Mr Powell and his colleagues want clarity and they are expected to hold interest rates steady at around 4.3 per cent on Wednesday.
Indeed, much of the hard data that has come in since March was tallied before tariffs took place.
These metrics showed the Fed's preferred inflation metric eased to 2.3 per cent annually – not far off from their goal – before tariffs took effect.
Job growth was also stronger than expected, with employers adding 177,000 positions last month while the unemployment rate remained a stable 4.2 per cent.
“Right now … there's nothing that screams action,” said John Leahy, an economics professor at the University of Michigan's Gerald R. Ford School.
Multiple scenarios could play out in the coming months. The economy could weaken to a degree that would see it drag into a recession, inflation could reaccelerate, or price-conscious consumers still reeling from the Covid-19 pandemic could adjust their longer-run inflation expectations.
“I don't think the Fed has any clue which of these futures is going to come to pass, so I would guess they just kind of wait and see what the data tell them,” Mr Leahy said.
A fork in the road
In addition to tariffs, other sources of economic uncertainty include changes in immigration, regulation and tax policies whose effects are still to be felt.
“We don't grasp fully how those are going to really shake themselves out in the next six to 12 months. So, that's a very difficult situation of the Fed to be in,” said Derek Tang, co-founder of LHMeyer advisory firm in Washington.
Grabbing headlines last week was a sour reading on the nation's gross domestic product (GDP), which shrank by 0.3 per cent as businesses stocked up on imports ahead of an expected increase in prices.
While not enough to signal a recession, the first-quarter slowdown raised concerns over how tariffs can effect the Fed's dual mandate of price stability and maximum employment.
co-founder, LHMeyer
Most economists argue Mr Trump's larger-than-expected tariffs will lead to both higher inflation and lower growth. While higher inflation would call for the Fed to raise rates, a reduction in unemployment and lower growth would call for a rate reduction.
“The Fed is between a rock and a hard place,” Mr Tang said.
Speaking in Chicago last month, Mr Powell said the Fed might be forced to choose between one or the other.
“If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close,” he said.
For now, and despite the economy shrinking last quarter, the labour market remains on solid footing.
Last week's Challenger report showed layoffs announced by US employers dropped in April, even though total layoffs were 63 per cent higher compared to the same time last year. Most of this year's 602,493 layoffs – the highest year-to-date total – have come from the government, with more than 281,000 cuts a result of Department of Government Efficiency slashing the federal workforce.
However, if uncertainty were to result in mass layoffs, it would be “game over”, Ryan Sweet, chief US economist at Oxford Economics, said during a media call.
“Once the number of people being laid off rise on a sustained basis, then that sets into that vicious cycle where rising unemployment rate causes people to cut back on spending, that leads to more layoffs around and around to go into a recession,” he said.
