Fed Holds Rates Steady Amidst Tariff Concerns: Powell Signals ‘Meaningful’ Inflation Ahead and Prolonged Fight for Price Stability

The U.S. central bank, the Federal Reserve, announced today its decision to maintain the benchmark overnight interest rate at its current range of 4.25%-4.50%. While policymakers still project potential rate cuts later in 2025, Federal Reserve Chair Jerome Powell issued a stark warning: the looming threat of new import tariffs by the Trump administration is expected to unleash “meaningful” inflation, complicating the Fed’s fight to return price stability to the American economy. This nuanced stance, revealed after a two-day Federal Open Market Committee (FOMC) meeting, paints a picture of an economy grappling with weaker growth, rising joblessness, and persistent price pressures, signalling a protracted battle to achieve the Fed’s 2% inflation target.

The Federal Reserve’s Steady Hand: Decoding the Dot Plot and Economic Projections

The decision to hold interest rates steady was unanimous among the 19 policymakers, reflecting a consensus on the need for continued patience amidst economic uncertainties. The benchmark overnight rate, a critical tool influencing borrowing costs across the economy, remains in a range designed to temper inflation without unduly stifling economic activity.

A key output from the FOMC meeting is the release of new economic projections, often visualized in what’s informally known as the “dot plot.” This scatter chart illustrates each policymaker’s individual projection for the federal funds rate at various points in the future. While the collective “dot plot” still pencils in two quarter-percentage-point rate cuts by the end of 2025, Chair Powell urged caution against interpreting these projections as firm commitments. “No one holds these…rate paths with a great deal of conviction,” Powell emphasized in his post-meeting press conference, stressing that all future policy decisions would be “data-dependent.” This means the Fed’s actions will be directly responsive to incoming economic data, rather than adhering rigidly to a pre-set schedule.

The revised economic projections paint a modestly stagflationary picture for the U.S. economy, a term that describes a challenging environment characterized by stagnant economic growth combined with rising inflation. Specifically:

• GDP Growth: Projected to slow to 1.4% in 2025, a downgrade from the 1.7% rate forecasted in March. This suggests a more sluggish expansion than previously anticipated, potentially impacting job creation and business investment.
• Unemployment Rate: Expected to rise to 4.5% by the end of 2025, up from the 4.4% projected in March. While the current unemployment rate in May stood at a historically low 4.2%, the anticipated uptick indicates a loosening of the tight labor market.
• Inflation: The year-end inflation projection for 2025 is now 3%, significantly higher than recent favorable readings and well above the Fed’s long-term 2% target. This upward revision underscores the central bank’s persistent concern about price stability.

Looking further ahead, policymakers have adjusted their outlook for future rate cuts. While they still foresee two cuts in 2025, mirroring their March and December projections, they have slightly slowed the anticipated pace for subsequent years, now forecasting a single quarter-percentage-point cut in both 2026 and 2027. This revised trajectory suggests a prolonged and arduous fight to bring inflation back to target. According to the new projections, inflation is expected to remain elevated at 2.4% through 2026 before finally nudging closer to the target at 2.1% in 2027, all while unemployment remains largely stable.

Adding to the complexity is a visible split among the 19 policymakers. Seven of them believe no rate cuts will be necessary this year, reflecting divergent assessments of the risks. Some may fear that inflation could remain stubbornly high, requiring a tighter monetary policy for longer. Others might be concerned about the potential for a weakening labor market, which could argue for less restrictive measures. This diversity of views, as Powell noted, is a reflection of a “very foggy time” for economic forecasting, particularly given the unpredictability of trade policy.

As Jack McIntyre, portfolio manager for global fixed income at Brandywine Global, summarized, “There’s still bias towards some version of stagnation, lower growth with rising sticky inflation. It feels like it’s a Fed that’s still being very patient, and they’re still biased towards cutting rates in the near future.” “Sticky inflation” refers to components of inflation that tend to be less responsive to changes in monetary policy, often due to structural factors or deeply embedded expectations.

The Tariff Conundrum: A ‘Meaningful’ Inflationary Shock on the Horizon

The most striking element of Chair Powell’s press conference was his candid assessment of the potential inflationary impact of the Trump administration’s planned import tariffs. Powell articulated a clear warning that these new levies could soon lead to a “meaningful increase in inflation” in the coming months, a critical factor influencing the Fed’s cautious stance on rate cuts.

“If not for tariffs,” Powell contended, “rate cuts might actually be in order, given that recent inflation readings have been favorably low.” This highlights the unusual predicament facing the Fed. Typically, low inflation readings would give the central bank more leeway to ease monetary policy, stimulating economic growth. However, tariffs introduce an external, artificial cost shock that distorts this picture.

The challenge, as Powell explained, lies in the “pass-through” effect of tariffs. When import duties are imposed, someone ultimately has to bear that cost. This involves a complex struggle between various entities in the supply chain:

• Manufacturers and Exporters in Origin Countries: They might absorb some of the cost to remain competitive, but often they will pass it on to importers.
• Importers: Businesses bringing goods into the U.S. will face higher costs. They, in turn, will try to minimize their losses.
• Retailers: The final link in the chain before the consumer, retailers will also aim to protect their profit margins.
• The End Consumer: Ultimately, a significant portion of the tariff cost is expected to fall on the American consumer in the form of higher prices for imported goods. This is akin to a cost-push inflation scenario, where rising production costs (in this case, due to tariffs) are passed on to consumers, rather than inflation driven by excessive demand (demand-pull inflation).

“Everyone that I know is forecasting a meaningful increase in inflation in coming months from tariffs, because someone has to pay for the tariffs…between the manufacturer, the exporter, the importer, the retailer,” Powell stated, underscoring the broad consensus among economic forecasters. “People will be trying not to be the ones who can pick up the cost. Ultimately, the cost of the tariff has to be paid, and some of it will fall on the end consumer.”

President Donald Trump has repeatedly contemplated an aggressive set of import duties, and while the uncertainty surrounding these policies has receded somewhat since its peak in April, it remains a significant wildcard for the economy. Businesses, manufacturers, and retailers are still engaged in a complicated struggle over how to absorb and pass on the levies already imposed, let alone the potential new duties that could go into effect as early as next month.

This “foggy time” in trade policy makes the Fed’s job exceptionally challenging. Powell emphasized the need for patience: “We’ll make smarter and better decisions if we just wait a couple of months or however long it takes to get a sense of really what is going to be the pass-through of inflation” from the higher import taxes. This “wait and learn” approach is crucial for the Fed to accurately assess the true inflationary pressures at play and to avoid making policy adjustments that could be counterproductive.

Geopolitical Tensions and Monetary Policy: A Delicate Balance

While global events often cast a long shadow on economic forecasts, the Fed’s official statement notably omitted any direct mention of the sudden outbreak of hostilities between Israel and Iran, or the potential risk this conflict poses to global oil and other markets. This deliberate omission reflects the Fed’s typical practice of focusing its formal statements strictly on domestic economic conditions and monetary policy, avoiding direct commentary on geopolitical developments unless their impact on the U.S. economy is immediate and quantifiable.

However, Chair Powell did address the conflict during his press conference, acknowledging that the Fed is “watching the conflict like everybody else.” He conceded that it’s “possible energy prices could rise” as a result of the tensions in the Middle East. Nevertheless, Powell maintained that such price spikes, particularly those driven by temporary supply disruptions, generally tend to “fade and don’t have lasting effects on inflation.” This assessment aligns with the Fed’s focus on core inflation, which strips out volatile food and energy prices to provide a clearer picture of underlying price trends. While headline inflation might experience short-term spikes due to energy costs, the Fed’s policy decisions are more heavily influenced by what they perceive as persistent, broader inflationary pressures.

This cautious yet observant stance underscores the Fed’s commitment to its dual mandate of maximizing employment and maintaining price stability. “For the time being, we are well positioned to wait to learn more about the likely course of the economy before considering any adjustments to our policy stance,” Powell reiterated. He added that the Fed is structured to “react” to incoming information in a timely and data-driven way, suggesting flexibility in its approach should circumstances change dramatically.

Political Pressure vs. Central Bank Independence: A Recurring Battle

The Federal Reserve’s latest action to hold rates steady, rather than yielding to calls for immediate cuts, once again highlights the persistent tension between political pressures and the central bank’s crucial independence. President Donald Trump has been an outspoken critic of the Fed’s policies, frequently demanding lower interest rates and even publicly chastising Chair Powell. On Wednesday, as Fed officials deliberated, Trump reportedly called Powell “stupid” and advocated for slashing the policy rate in half – a type of drastic monetary easing typically reserved for severe economic emergencies. He even mused about the possibility of installing himself as Fed chief, a move that would fundamentally undermine the independence of the institution.

The Fed’s independence from political interference is a cornerstone of its effectiveness in achieving its mandates. This autonomy allows the central bank to make decisions based purely on economic data and its long-term objectives for price stability and maximum employment, without succumbing to short-term political expediency. Historically, presidents have often preferred lower interest rates to stimulate economic growth, especially during election cycles. However, the Fed’s role is to ensure sustainable economic health, which sometimes requires unpopular decisions like raising or holding rates to curb inflation.

Fed officials are acutely aware of the political pressures, but their public statements consistently emphasize their focus on economic fundamentals. Their reluctance to commit to a rapid timeline for further cuts stems precisely from their effort “to ensure inflation returns to the 2% target until key tariff changes are finalized and their effects are better understood.” To cut rates prematurely in the face of anticipated inflationary pressures from tariffs would be counterproductive to their primary objective of price stability, potentially allowing inflation to become entrenched. This complex balancing act requires a steadfast commitment to the Fed’s mandate, even when faced with significant political scrutiny.

Market Reaction and Forward Trajectory

In the immediate aftermath of the Fed’s announcement, U.S. stock indexes remained largely flat, while the 10-year Treasury yield was mostly unchanged. This muted market reaction suggests that a significant portion of the Fed’s message – including the likelihood of prolonged patience and the impact of tariffs – may have already been priced in by investors. Markets often anticipate central bank actions, and the Fed’s communication strategy aims to guide these expectations to avoid sharp, unexpected movements.

Despite the Fed’s cautious stance, interest rate future prices continued to indicate that the Fed’s September 16-17 meeting was the most likely point for the next rate cut, with another reduction in borrowing costs likely by the end of 2025. This indicates that while the market acknowledges the challenges and the Fed’s patience, it still holds a stronger conviction that economic conditions will eventually warrant easing monetary policy within the year.

The concept of forward guidance is crucial here. Central banks use forward guidance to communicate their future policy intentions, aiming to influence market expectations and long-term interest rates. While Powell stressed that the rate paths are not set in stone, the projections, even with their internal splits, still offer a directional signal to the market.

In conclusion, the Federal Reserve faces a complex and highly uncertain economic landscape. The decision to hold interest rates steady reflects a blend of patience and concern, particularly regarding the inflationary impact of potential tariffs. Chair Powell’s candid remarks underscore the central bank’s commitment to a data-dependent approach, adapting its policy in real-time to evolving economic conditions. As the U.S. economy navigates weaker growth, sticky inflation, and significant political pressures, the Fed’s independent, methodical approach will be crucial in steering it towards the twin goals of price stability and maximum employment. The coming months will be critical in determining how the interplay of trade policy, geopolitical events, and domestic economic trends shapes the Fed’s path forward.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

19th June, 2025