A few days after President Trump won the 2024 election, Federal Reserve Reserve Chairman Jerome H. Powell declined to question how central banks tackle the toxic combination of high inflation, stagnation and increased unemployment.
“The whole plan isn't about having a stag,” Powell told reporters. “Knocking on the wood and we got here without seeing it really weakened in the labour market.”
Two months later, Trump's aggressive declaration of tariffs, novel cuts to the federal government, and the resulting financial market frenzy put the Fed in a very uncomfortable place.
Full stagflation remains a remote outlook. The foundations of the US economy remain solid and require a significant impact to collapse. But what once seemed to be a historic soft landing seems increasingly vulnerable as the Fed seizes rapid inflation while keeping the economy intact.
As the Fed concludes its policy meeting on Wednesday, it is widely expected that interest rates will remain stable at 4.25-4.5%. Powell recently downplayed the need for immediate changes to borrowing costs, saying that the central bank is focusing on “separating signals from noise” in terms of Trump administration policies. With the economy in a good place, the Fed is “in a good position to wait for it to become clearer,” he said.
But when the economy starts to crack and inflationary pressures begin to rise, consumers are increasingly afraid – the Fed's policy decisions place a whole new degree of difficulty. That danger would be dangerous if the central bank was placed more straighter on Trump's crosshair.
“There's certainly a dilemma with the Fed,” said Mahmood Pradhan, Head of Global Macros at the Asset Manager Amundi Investment Institute. “The Fed does not control this background, does not control policy uncertainty, or control the volatility of this discussion about tariffs. That's the very tough hand they've been dealt with.”
Central bank officials have become clever by dodging questions about Trump and his policies. But the gusts of action taken by the Trump administration in the first two months of his second term made it much more difficult.
The vast amount of tariff threats alone has exploded the scope of possible economic outcomes. It's rattle even the most optimistic economists about the outlook. They also had to contest the sudden spending cuts that came in the efficiency of Elon Musk and his government and the prospects that millions of migrants could be deported.
Trump's reluctance to rule out the recession and a recent shift in tone from top advisors on the amount of pain needed to achieve the promised economic boom has amplified fears about how far the administration will go to push his agenda. These fears got worse last week as Trump rejected the warning signs, causing financial markets to be unsettled.
There is evidence that uncertainty about tariffs is already beginning to bite. Consumer sentiment fell sharply in March for the third consecutive month, according to a preliminary survey conducted by the University of Michigan and released Friday.
According to Factset, tariff talks have skyrocketed corporate revenue calls, with the CEO increasingly warning about sluggish demand and rising prices. Expectations about the labor market are also declining, with the share of consumers surveyed by the Federal Reserve Bank of New York increasing, with future unemployment rates rising and financial situations expected to be poor.
“Consumption, which has been a key driver of the US economy over the past few years, will no longer bring about that impulse,” said Mark Giannoni, chief economist at Barclays, who previously worked for the Federal Reserve Regional Banks in Dallas and New York.
Last week, Giannoni's team cut US economic growth forecasts by nearly all points, down to 0.7% on a fourth quarter basis. Economists at JPMorgan and Goldman Sachs have moved their estimates in a similar direction, citing expectations that increasing uncertainty in tariffs and trade policies would block investment and employment.
One of the annoying signs is that they did while raising predictions of inflation. Companies are paying higher prices from Trump's tariffs, increasing the costs of imports. Many warn that they are likely to communicate those increases to consumers.
Tom Madrecki of the Consumer Brands Association said the large food companies his trade group represents could be hurt if unused products are hit by tariffs, such as the PepsiCo, General Mills and Conagra brands, if unused products are not easily sourced in the country.
“We won't win in this situation,” he said. “There's no way grocery prices don't rise, but at the same time, consumers have clearly reached a breaking point.”
The group recently sought Trump for tariff exemptions on products such as coffee, cocoa and oats, which are sourced primarily overseas.
Madrekki said the exemption will allow businesses to “avoid costly eating.”
Americans are already beginning to expect higher prices. Inflation expectations are rising sharply. This is rising both on the longer horizon of one year ago and five years. Some economists have downplayed how much signal should be collected from those measures due to the increasingly partisan nature of some responses. Despite changes in research-based measures, market-based measures are also stable.
However, the widening range of responses about where inflation is heading is a source of concern for others.
“We're looking forward to seeing you in the world,” said Yuriy Gorodnichenko, an economist at the University of California, Berkeley. “Everyone is so uncertain and confused, so it's very easy to change people's beliefs from one number to another.”
How inflation expectations evolve is important to how the Fed outlines its policy path. Central banks have historically argued that these price pressures tend to be temporary and that they can avoid responding to tariff inflation. By lowering interest rates in 2019, the Fed responded to growth concerns that emerged during the last global trade war in Trump's first administration.
However, central banks risk more bumping in their response to economic weakness, as inflation still exceeds the 2% target. Powell said this month that the Fed's approach to navigating tariffs will ultimately depend on “what's happening with long-term inflation expectations, how long the inflation effect is,” suggesting that the central bank's focus is primarily on price pressure.
John Faust, a senior adviser to Powell, was Powell's senior adviser last year.
The additional complication is Trump's preference for testing the Fed's political independence. The president has so far refrained from commenting frequently during his first term on Powell and the Fed's policy decisions, but he has attempted to make a more serious intrusion into the agency through executive orders.
“President Trump doesn't seem to have been bound by customs more than he last time,” said Faust, who is now at the Center for Financial and Economics at Johns Hopkins University. “It seems the economic situation will be easier in terms of lower economic conditions and potentially increased tariff-driven inflation, a prescription that is very likely to lead to a serious conflict between the Fed and the administration.”