Three Reasons The Fed Will Stand Pat On Interest Rates

Despite President Donald Trump’s public efforts to cajole the Federal Reserve into lowering interest rates, monetary policy is rightly locked on hold over the near-term for three reasons.

First, the uncertainty surrounding the Trump administration’s tariff regime remains unusually high. Not only is tariff policy ever changing in terms of countries, products, rates and rationale, but also the timeline for resolution continues to be pushed back, as evidenced by the April 1 and July 9 deadlines that have come and gone. Attention is now on the Aug. 1 deadline, which is two days after the central bank next meets to set monetary policy.

Trump’s decision to slap 50% tariffs on Brazilian imports because of the prosecution of his friend, former President Jair Bolsonaro, underscores just how far the President’s rationale for higher tariffs can extend beyond purely economic reasons. As Bloomberg News reports, Brazil is unusual among Trump’s most recent tariff targets because it runs a deficit in trade with the US.

Second, because the impact of higher tariffs on the US labor market and inflation has been quite limited to date, it’s too soon to judge on which side the risks will dominate, whether through a weaker labor market or higher inflation rates.

On labor, the economy remains close to Fed officials’ estimates of full employment, with the jobless rate oscillating in a narrow range of 4% to 4.2% over the past 12 months. Although payroll employment growth has slowed and the hiring rate has diminished, that has been offset by slower growth in the labor force, caused, in large part, by the crackdown on illegal immigration and higher deportations along with the fact that layoffs remain muted.

On inflation, the pass-through of tariffs into the prices consumers pay of goods has been muted. Although core consumer goods prices have been flat over the past three months, this may just reflect the lag between when goods are ordered and when they finally land on retail shelves. It also may reflect a decision by businesses to adjust prices more gradually over time to make the increases less visible (and less jarring) to customers. Feathering in the costs over time also has the benefit of forestalling demands from Trump — such as hemade to Walmart Inc. — to just absorb the cost.

Third, there is no compelling need to act because monetary policy is not exerting significant restraint on economic activity. Chair Jerome Powell has downgraded his characterization of policy to being only “modestly” restrictive from “moderately.” In fact, judging from the recent easing of financial conditions and the resilience of the economy, monetary policy may not be exerting any restraint at all. A buoyant equity market and a weaker dollar have caused overall financial conditions to ease considerably this year even as monetary policy has been on hold. The cost of waiting is low as long as the risks to the Fed’s inflation and employment mandates are judged as broadly in balance.

The media are emphasizing the split in desired policy, highlighting the disparity in the June Summary of Economic Projections between the seven members of the rate-setting Federal Open Market Committee that had no rate cuts penciled for 2025 versus the 10 that anticipated two or three cuts of 25 basis points each. Outside of Governor Michelle Bowman and Governor Christopher Waller — the two Trump appointees on the Board that are advocating for a July rate cut - I think the significance of the split is exaggerated.

The rate projections likely differ because of different assessments about: 1) the outlook for trade policy and tariffs; 2) the amount of the passthrough of higher tariffs into inflation and the consequences for inflation expectations; and 3) the current stance of monetary policy. Tariff policy and its impact on growth and inflation will become clearer over the next few months, including whether higher prices lead to higher inflationary expectations. Also, the economy’s performance will provide insight into the tightness of monetary policy. As this occurs, the disparity in the rate projections as seen in the so-called dot plot will diminish.

The reluctance of the Fed to cut rates will undoubtedly lead to further Trump attacks on the central bank, and Bowman and Waller will continue to advocate for looser monetary policy. In fact, the pressure could intensify as the leading candidates to succeed Powell — Treasury Secretary Scott Bessent, National Economic Council Director Kevin Hassett, Waller and former Fed Governor Kevin Warsh — continue to seemingly audition for the job publicly.

None of this is likely to sway Powell. Rather, such pressure makes it more difficult for the Fed to cut rates. If Fed officials were perceived to have caved to political pressure, concern about the Fed’s independence would rise, increasing the risk that inflation expectations become unanchored.

Source: Bloomberg Europe