The recent sell-off in the stock market, triggered by unrelenting tariff headlines, is staggering and consumer confidence is at multi-year lows. Despite a monster rally in the middle of last week, and U.S. President Donald Trump hitting a 90-day pause on tariffs, the market is still striving to find its footing, even as core inflation rate eased to a four year low. The Federal Reserve appears as baffled as the rest of the world about the future direction of the economy in a new landscape paved with tariffs and reciprocal tariffs.
In fact, the Fed is grappling with a unique dilemma: the dual challenge of a potentially weakening economy alongside inflationary pressures fueled by tariffs – two conflicting problems that call for different responses. A weakening economy will require shoring up with interest rate cuts, while inflationary pressures will typically need to be tamed by keeping interest rates higher. Adding more complexity to the mix, President Trump is putting pressure on the Federal Reserve to cut interest rates.
This tension came into sharper focus during Fed Chair Jerome Powell’s April 16th speech at the Economic Club of Chicago, as he addressed the central question – will the Fed sit back and watch as market volatility continues to erode household wealth and stifle economic activity, or will it cut rates to stabilize the economy, but possibly igniting inflationary pressures along the way?
Understanding Interest Rates And Impacts
New tariffs are expected to push up prices on essentials like cars, clothes and electronics, sparking fresh inflation fears. When inflation spikes, the Fed typically raises interest rates to cool the economy by making borrowing more expensive and slowing spending. On the flip side, when growth stalls, the Fed cuts rates to boost borrowing, spending and hiring. Lower interest rates also make housing more affordable by reducing mortgage rates.
Central banks like the U.S. Federal Reserve do a delicate balancing act here – to keep inflation under check, while supporting economic growth. The Fed cut rates by one percentage point between September and December 2024, bringing the federal funds rate to 4.25%-4.5% before pausing in January. Inflation dropped to 2.4% in March -the lowest in six months, while core inflation, which excludes food and energy prices, hit a four-year low. Typically, cooling inflation will be a cause for euphoria, but the market remains whipsawed by incessant tariff news. This is because economists think this is perhaps the best inflation point before tariffs kick in and skew the picture.
With the core inflation of 2.8% closer to its long-term inflation goal of 2%, will the Fed step in and cut interest rates at the next FOMC meeting in May? It appears unlikely. Here’s why.
Factors Impacting Interest Rates In 2025
The current policy environment includes only a temporary 90-day reprieve on increased tariffs for many U.S. trading partners, while a 10% baseline tariff remains in place. In the case of China, an “at least” 145% tariff continues to apply. These measures contribute to ongoing uncertainty and inflationary pressures.
Powell has not ruled out the possibility of interest rate cuts later this year. However, he has signaled a cautious, data-dependent approach, suggesting the Fed will monitor the broader impact of trade policies on economic fundamentals carefully before intervening. It is interesting that the Fed still expects inflation to decline to its 2% target by 2026 or 2027, because even before Trump returned to the oval office, inflation has stubbornly remained above the Fed’s 2% goal.
However, the Fed signals slower growth expectations and higher core inflation by year-end, due in part to the expected impact of implemented and retaliatory tariffs. Gross domestic product (GDP) growth forecast has been revised down to 1.7% from 2.1% projected in the December FOMC meeting, while projection for core inflation for 2025 is raised to 2.8% from 2.5%. The year-end unemployment rate projection is revised to 4.4% from 4.3%. The policy maker is also easing the pace of quantitative tightening in April by cutting the monthly cap on U.S. Treasuries redemption to $5 billion from $25 billion. The opposite of QE, quantitative tightening involves the Fed offloading the government bonds on its balance sheet.
Tariffs have certainly complicated the forward direction for the Fed, intensifying concerns about added inflationary pressures and a souring economic outlook. Inflation is set to rise because of tariffs. This means the Fed will have to raise interest rates or at least hold rates steady, unless or until there are evident signs of deterioration in the job market. The Fed is not prone to preemptive strikes to ward off a downturn that is yet to materialize. It needs to see visible signs of weakness in the job market, either through rising unemployment rates or a slowdown in hiring activity. In March, The U.S. added 228,000 jobs, and the unemployment rate ticked up to 4.2% from 4.1% in the previous month. This data hardly makes the case for the Fed to start cutting interest rates yet.
Powell reinforced this perspective during his April 16th speech. He noted that longer-term inflation expectations remain aligned with the Fed’s inflation targets and described the labor market as being in “solid condition” and “at or near maximum employment.”
However, if the Fed were to face a situation where its twin mandate goals are in conflict, like rising inflation and rising unemployment, Powell stated, “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.”
Are Interest Rates Likely To Come Down In 2025: Expert Predictions
The Federal Reserve may likely consider easing rates in the second half of the year, particularly as greater clarity develops around the economic impact of tariffs and broader inflationary trends. However, the Fed has reiterated that it will not jump the gun unless there is tangible evidence of contraction in economic activity and deterioration in the labor market. If signs of economic distress take longer to manifest, potential rate cuts could be delayed until late 2025 or even into 2026,
“Despite heightened uncertainty and downside risks, the U.S. economy is still in a solid position,” Powell stated on April 16th, although he acknowledged that growth slowed in the first quarter from last year’s solid pace.
Economists are embracing a more pessimistic outlook for the U.S. economy, with several raising the probability of a recession alongside expectations of elevated inflation. A growing consensus suggests that tariffs could ultimately drive the unemployment rate above 5%.
Michael Feroli, Chief U.S. Economist at J.P. Morgan, anticipates the Federal Reserve will begin cutting interest rates in September, vs. his prior expectations for a rate cut starting from June. JP Morgan puts the odds of a U.S. recession at 60%, because of Trump’s tariff plans. Goldman Sachs forecasts three consecutive quarter-point cuts beginning in June, pulling forward a July timeline and sees a 45% probability for recession.
On the other hand, Seth Carpenter, a former Federal Reserve economist and now Global Chief Economist at Morgan Stanley, does not anticipate any rate cuts this year but expects significant easing in 2026, ultimately bringing the federal funds rate down to a range of 2.5% to 2.75%. Similarly, economists at research firm LHMeyer have also postponed expectations for rate cuts this year, contingent on the absence of a “full-blown” recession.
What Investors Should Watch Going Forward
During a stock market rout, American investors are usually one of the most-impacted globally, seeing significant destruction of personal wealth, as their retirement savings accounts – 401(k) and IRA are largely tied to market investments.
At this point, it’s unclear whether the newly imposed tariffs are primarily a negotiating tactic or a long-term strategy. If the former, a swift market rebound is possible. But if President Trump is firmly committed to prolonged protectionist policies to address trade imbalances, investors could see continued market turbulence and potentially deeper losses.
The Fed is not coming to the rescue if the market takes a deeper dive. Powell vetoed a “Fed Put” on April 16th, when asked if the Fed would intervene to support the market. He explained that while stock and bond markets were battling uncertainty and volatility, they are still functioning as expected.
Much like how strong leadership drives performance in individual companies, the broader market also takes cues from Washington. The current administration’s communication has been mercurial in nature, marked by unpredictability and a lack of clarity and detail, which heightens uncertainty and volatility. And, there’s a worse corollary.
If investors begin to lose confidence in the government’s ability to steer the economy effectively, the repercussions could be lethal. There is already growing unease on the exodus of U.S. assets. Traditionally, during market turmoil, U.S. Treasuries and the dollar serve as global safe haven assets. But now, the simultaneous declines in equities, bonds, and the U.S. dollar are rattling markets. If the safety of the U.S. dollar as a global reserve currency is questioned, it could lead to rapid de-dollarizing. This could have sweeping implications for America’s economic standing.
Key Watchpoints For Investors:
- Fed policy decisions (especially the May FOMC meeting)
- Speeches of Fed members
- Inflation prints and job market data
- Foreign central bank responses to U.S. tariffs and monetary policy
- Continued strength or weakness in the U.S. dollar
What Could Be A Prudent Investment Strategy During Market Turbulence?
While it’s common advice to “stay calm” during market volatility, recent sharp declines in both bonds and the U.S. dollar suggest that a more nuanced approach may be warranted. I like:
Gold: Often considered a safe haven, can shine during financial turbulence, even a self-inflicted one.
Domestic-Focused Equities: Companies that rely on domestic supply chains with no or less exposure to global trade tensions or tariffs – may offer relative stability.
Japanese Yen: The yen has historically performed well during periods of global risk aversion and could serve as a strategic currency hedge.
High-yield savings accounts (HYSA) remain a viable option while interest rates stay elevated, and choosing accounts that are FDIC-insured should reinforce capital security.
Bottom Line
The Federal Reserve may consider easing rates in the second half of the year, depending on how tariffs and inflation trends unfold. If economic distress is slow to manifest, rate cuts could be delayed into late 2025 or even 2026. Much depends on whether tariffs are short-term negotiating tools or part of a longer protectionist strategy – either way, market volatility may persist. With sharp declines in both bonds and the U.S. dollar – assets like gold, domestically focused equities, the Japanese yen and HYSAs could offer more relative stability amid ongoing uncertainty.
Please note that I am not a registered investment advisor and readers should do their own due diligence before investing in the stocks mentioned in the article, or any other stock. I am not responsible for the investment decisions made by individuals after reading this article. Readers are asked not to rely on the opinions and analysis expressed in the article and encouraged to do their own research before investing.
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