Inflation falls and the trade war stalls: What it means for Fed interest rate cuts
Shannon Carroll
6 min read
Photo: Andrew Harnik (Getty Images)
The Federal Reserve has been playing a waiting game for months. A lot has changed this week. And the Fed will probably just keep playing the waiting game.
Economists were encouraged by the data. But tariffs, supply chain issues, and the prospect of more inflation soon are lurking beneath the surface. President Donald Trump has been pressuring Federal Reserve Chair Jerome Powell to cut interest rates. Will a trade war truce and a good inflation reading lead Powell to pull the trigger?
Don’t count on it.
Many economists still believe the Fed will hold steady, with rate cuts likely only on the table in the months (and months) ahead.
David Mericle, the chief U.S. economist at Goldman Sachs (GS) said in a note Monday that with tariffs dropping faster than expected, the Fed won’t feel any urgency to cut rates to stimulate economic activity. Goldman now expects the Fed to begin a series of three rate cuts even later than previously thought — in December, rather than July — and to space them out at every other meeting, rather than in quick succession.
“In our new economic baseline, the justification for rate cuts shifts from ‘insurance’ to ‘normalization,’” Mericle wrote. “As growth holds up and unemployment rises less sharply, the need for aggressive policy support diminishes.”
Given lingering uncertainty, the temporary trade war pause may not be the immediate win President Donald Trump was hoping for.
Jeffrey Roach, the chief economist for LPL Financial (LPLA), said in a note Monday that the preliminary deal will “provide some clarity on the future path of inflation.” But he also said “the uncertainty about what might happen after these temporary trade deals makes things difficult for the Fed since stagflation remains a risk.”
“If the fog does not clear,” Roach added, the Fed might not be able to adjust policy during its next meeting in June.
Sticky inflation remains a concern
It’s not just the trade war influencing the Fed. It’s also the bigger picture. Inflation, though cooling, is still above the central bank’s 2% target and remains volatile. The full impact of Trump’s “Liberation Day” tariff announcement didn’t show up in April’s CPI data.
Daniel Hornung, former Deputy Director of the National Economic Council, said in a note Tuesday that, “The questions now are how much inflation increases when the tariffs get passed through to consumers, how much that hits real income and consumption, and whether the economy can withstand those impacts without entering a recession.”
And while inflation is far down from its peak, it’s still sticky — particularly in areas such as housing and services, which tend to be slower to adjust. Deutsche Bank (DB) analyst Jim Reid wrote in a note Tuesday that while tariff cuts could help lower inflation, other factors — such as sector-specific tariffs and a weaker dollar — could drive inflation higher. Deutsche Bank expects the Fed to remain cautious for now.
“We maintain our view that the Fed will find it hard to ease in the near term, and the first cut pencilled in for December remains the base case,” Reid wrote.
While the April CPI reading may be a step in the right direction, it’s not enough to trigger a quick rate cut. For now, Powell has no incentive to be anything other than patient.
The road to rate cuts is a long one
Despite the trade war fears that have dominated recent weeks, far more than tariffs drive inflation. High prices for energy and housing, persistent supply chain issues, and labor market tightness all contribute to inflationary pressures that the Fed has to consider. The U.S. economy contracted by 0.3% in the first quarter of 2025, while the labor market showed resilience with 177,000 jobs added in April — a figure that modestly exceeded expectations.
The new inflation shows that core CPI — which strips out food and energy — rose just 0.24% month-over-month, below expectations, and came in at 2.78% year-over-year. Airfares fell by 2.8%, possibly due to softer demand for business and tourism travel. Used car prices, long a hotbed for inflation, fell by 0.5%.
On the flip side, prices for things such as car insurance, furniture, and medical services have been creeping up, and rent, a notoriously sticky component of inflation, continues to rise.
The Fed has a delicate balancing act: trying to keep inflation on its downward trajectory while not stifling the economy.
“The economy itself is in solid shape,” Powell said at the central bank’s meeting last month. He added, to some laughs from reporters, that “my gut tells me that uncertainty about the path of the economy is extremely elevated.”
Why the Fed is still playing it safe
Trump’s pressure on the Fed to cut rates has been immense and increasingly threatening. Since taking office, he has repeatedly called on Jerome Powell to lower the base rate — which currently sits between 4.25% and 4.5% — and at times has raised the legally dubious prospect of ousting him.
But despite Trump’s rhetoric, Powell has remained steadfast, sticking to the Fed’s dual mandate of controlling inflation and maximizing employment.
And while this week’s tariffs truce might ease some inflationary concerns, it’s unlikely to spur the Fed into acting immediately. The real question is whether the global economy will calm down enough for the Fed to act decisively.
“The Fed meeting came and went largely as expected,” Jeremy Siegel, finance professor at the Wharton School, wrote Monday in his weekly column. “Those hoping for clarity on a path for rates cuts only received confirmation Jerome Powell remains hesitant to act. … His refusal to shift policy reveals a broader problem: the Fed’s rigid operational framework has locked it into a reactive stance.”
Powell has emphasized that the central bank is focused on achieving “greater confidence” that inflation will return to its 2% target, rather than waiting for it to reach that level before considering rate cuts. He has previously said that monetary policy operates with “long and variable lags,” implying that waiting until inflation hits 2% could be too late to prevent it from overshooting.
So he’s not adverse to acting — as long as he sees fit.
Powell said recently that the risks of higher unemployment and inflation have risen, and the current policy stance leaves the Fed “well positioned” to address economic developments “in a timely way.”
The Federal Open Market Committee has projected a 50 basis-point reduction in interest rates for 2025, which would bring the federal funds rate to 3.9%.
For now, the economy is holding its breath — and so is the Fed.
