In just half a year, the US economic outlook has changed dramatically, upsetting the Federal Reserve's plans to cut interest rates.
At his inauguration in January, President Donald Trump declared that "A golden age of America has begun." He said his top goal was to "build a proud, prosperous, and free country."
However, in the eyes of Fed officials, this commitment has not yet come true. On the contrary, they only see the President's policies as dragging down economic growth, causing unemployment and inflation to rise. The final import tariffs on countries have not been finalized, leaving markets uncertain.
The Fed responded by delaying the rate cut until at least the fall. The pace of the rate cut has also been adjusted to slow down. This means they expect inflation in the coming months to be higher than when Trump took office.
This is not good news for Trump. The US President has repeatedly criticized Fed Chairman Jerome Powell as "slow and stubborn" for not cutting interest rates. This is also not good news for American consumers and home buyers, who are hoping for lower borrowing costs. The Fed's actions also go against the trend of many other major central banks, such as Switzerland and Europe.
People shop at a shopping mall in Pennsylvania (USA). Photo: ReutersHowever, this shows that Trump's policies, especially import tariffs, have changed the short-term outlook for the world's largest economy. At the end of last year, the US was still assessed as growing above average, the labor market was at full employment, and inflation was gradually falling towards the Fed's 2% target.
"The US economy is in very good shape. The outlook is very bright," Powell said after the meeting on December 17-18.
But now, the plan to cut interest rates consecutively, expected six months ago, has been replaced by a more cautious path. Fed officials want to wait for Trump's final decision on taxes and monitor developments in the labor market, consumption and inflation. In the first quarter, US GDP decreased by 0.3%, mainly due to businesses increasing imports of goods before the new tariffs took effect.
"A lot of things about tariffs will become clearer this summer," Powell said last week, after the Fed announced it would keep its benchmark interest rate unchanged at 4.25-4.5%.
President Trump has used recent cooling inflation data to call for the Fed to cut rates. He has mentioned it almost every day over the past week. He cited the European Central Bank (ECB) and other banks that are still easing monetary policy.
However, when mentioning the tariffs that have been applied, Powell said: "We don't think they have much impact at this point. And in fact, they haven't. We'll see how they affect us over the next few months."
Currently, investors expect the Fed to cut rates at its September 16-17 meeting. However, this depends on what Powell observes over the summer.
Reciprocal tariffs, Mr Trump's most aggressive import tax plan, were announced in early April. However, the policy was postponed after US bond yields spiked, stocks plunged, and economists began to raise their forecasts for a recession.
The 90-day tariff deferral expires on July 9. If no deal is reached, US trading partners will be hit with import tariffs of up to 50%. So far, the only deal the US has concluded is a limited agreement with the UK.
In its policy statement last week, the Fed said that "uncertainty about the economic outlook has decreased" since its May meeting. Powell said the economy remains "resilient" and that businesses have begun to adjust to lower import tariffs.
"Businesses were pretty shocked in April. But now people are finding their way through it. The mood is much more positive and constructive than it was three months ago," he said. Stocks have rebounded, and Treasury yields have fallen.
But he warned that things could change quickly as July 9 approaches. "We don't know for sure how things will turn out," Powell said.
It's a positive that the economy has avoided the brink of recession. But the current situation is still far from where it was at the end of last year, when the Fed was optimistic that the US economy could have a "soft landing" after a period of high inflation during the pandemic.
In forecasts released last week, Fed officials now expect GDP growth this year to fall to 1.4%, down from 2.1% in December. The unemployment rate is expected to rise from 4.2% now to 4.5% by the end of the year. That would be the highest figure since early 2017, excluding the pandemic.
Inflation, which Powell once said was “decreasing,” is now expected to hit 3% this year and stay above 2% through 2026. Powell said the labor market remains strong, but warned that the assessment could change. Fed officials also said their expectations for monetary policy could change quickly if the labor market weakens.
“Demand for labor is falling. There aren’t a lot of layoffs, but there aren’t a lot of new jobs being created. If you’re unemployed, it’s going to be very hard to find a job,” Powell warned.
(via Reuters)