Fed Watch - No rate cut in sight
As expected, the Federal Reserve kept rates on hold today, maintaining the upper bound of the federal funds rate at 4.50%. The key update in the policy statement was that uncertainty about the outlook has increased further. Risks of higher unemployment and higher inflation have risen. Powell acknowledged that Trump's tariffs were higher than anticipated but noted that tariff talks are currently in a new phase of negotiations, which could change the picture materially, or not. Powell reiterated that the only response to this level of uncertainty is to wait and see, and that the Fed is well-positioned to react in a timely manner.
Powell emphasized the four areas of the Trump administration's policies that affect the Fed's mandate - tariffs, immigration, fiscal policy, and regulation - but the focus was on tariffs. He highlighted the uncertainty about the magnitude and timing of tariffs and the resulting degree of persistence of the inflationary shock. He noted that the Fed is ill-positioned to deal with such a supply shock, which creates tension in the Fed's dual mandate, but that their ultimate policy would weigh the distance to target in employment and inflation, and the time it would take to return to target.
Despite historic changes in sentiment, hard real data has yet to show the impact of tariffs, with inflation moving sideways, no significant downturn in the labor market, and Private Domestic Final Purchases (PDFP) growth, which excludes inventory investment, government spending and importantly, net imports, still growing at 3.0% annualized in Q1. Powell seemed to indicate that in this uncertain environment, only hard data could sway the Fed to move. He noted that such data may move quickly or slowly, whilst also stating that if tariffs were implemented as currently announced, the Fed would make no progress on its mandate for the next year, providing an estimate of the extent of this pause. They see the cost of waiting as low.
Powell received various questions on the Trump administration's policy and his interaction with Trump. He declined to answer but made a small jab at the current tension: "I think they don't need my advice, and our advice, on how to do fiscal policy, any more than we need their advice on monetary policy".
Overall, the message was consistent with our current base case of the Fed being in wait-and-see mode until the overall tariff impact becomes clear. We believe the tariff impact will make the price stability part of the mandate binding, with only a moderate unemployment impact. Yet, the inflationary impact will not be so large as to warrant further rate hikes. We continue to think the Fed will maintain the current mildly restrictive rate for an extended period, only easing later next year.