Weekly Economic Trends and Indicators
The Headline:
The Federal Reserve kept the target for the federal funds rate in the range of 4.25 to 4.5% at their meeting last week. While this was the expected outcome, recent data on economic activity and inflation, as well as this week's announcement of reduced tariffs on Chinese imports, have increased speculation about the future path of interest rates.
The Details:
Because this was the first Fed meeting since the April 2nd tariff announcement, the market was anxious to hear how the Fed would factor tariffs into the monetary policy decision. In the press conference following the meeting, Federal Reserve Chair Jerome Powell said this about tariffs:
If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer-term inflation expectations well anchored.
As if to underscore the uncertainty surrounding tariffs, on Monday the Trump administration announced a 90-day pause in the 145% tariff on Chinese goods, reducing the rate to 30%. While this is still significantly higher than before the trade war began, it is low enough to allow most trade to continue. Whether this will be the final number is unknown, and indeed, most believe that there will continue to be modifications to tariffs on China as well as other countries.
The Context:
The Federal Reserve has a dual-mandate of price stability and maximum employment. However, it is often difficult to achieve these goals simultaneously. This is especially the case when the threat to economic growth (and therefore, employment, which tends to follow closely with economic growth) is from the supply side of the economy. Because tariffs run the risk of disrupting supply chains by making intermediate goods more expensive, they could both increase prices and reduce the quantity produced and sold.
The mechanism by which prices are affected is, as Powell notes in the quote above, a complicated process. Tariffs are usually not fully passed through into prices, but only partially. How much pass-through occurs depends on how sensitive foreign sellers and U.S. buyers are to changes in price. That differs across goods. There is no one answer, and the adjustment process takes time. Powell addressed what happens when these supply side factors become challenging.
We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension. 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.
Monday's news highlights one of the difficulties for policymakers at the Federal Reserve. Monetary policy works with a lag. Excessive gyrations in interest rates would destabilize financial markets and the broader economy. If the Fed had reacted to the 145% tariff on China by lowering interest rates to avoid a potential recession, they would have increased the risk of inciting inflation now that the tariffs are paused. For now, the Fed is willing to wait until it becomes clearer which way they will need to pivot. That could mean no change to short-term rates until July or later. In short, they are trying to balance the risk of making a move in the wrong direction against the risk of moving too late.
Next week: Quad Cities labor market update
