Markets will be laser focused on Federal Reserve policy and economic projections next week, looking for signs about where interest rates are heading. Unfortunately, policymakers, led by Chair Jerome Powell, face a backdrop unlike any they’ve confronted before, and it’s likely to leave them as confused as the rest of us.
New inflation data published this week suggest the core personal consumption expenditures deflator — the price gauge that is most closely watched by Wall Street for monetary policy implications — probably remained too high for comfort in February. With most inputs in hand, Bank of America Corp. economists estimate that core PCE increased 0.3% in the month (a 2.7% rise on a year-over-year basis), with some risk that the final number could round to 0.4%. That’s too high for the Fed to consider cutting rates, despite deteriorating sentiment and market worries about a broad economic slowdown.
To make matters worse, President Donald Trump’s trade war has triggered a swoon in markets, and dented business and consumer sentiment due to its potential to both hurt growth and raise prices further. At the time of writing, the S&P 500 Index was down more than 9% from its peak and the Nasdaq-100 was down more than 12%.
While tariffs are ultimately paid by the country where products are consumed, retailers can choose to pass them through to consumers or “eat” the higher prices through reduced profit margins. In Trump’s first trade war, growth jitters proved to be the more dominant effect. Despite well-documented price impacts at the product level, overall inflation never got out of control, and the Fed ended up cutting policy rates. Even when consumer prices rise in response to tariffs, the textbook response would have policymakers “look through” the one-time shock. But there’s no guarantee that the latest episode will be comparable to the first Trump trade war, nor is there any guarantee that the tariff effects will be one and done.
So far, the tariffs have been cascading through the global economy on a very staggered basis. New China tariffs were implemented and then raised; steel and aluminum tariffs have gone into effect; and Mexico and Canada tariffs have been in an on-again-off-again limbo. Still pending or threatened are a variety of product-specific tariffs and what Trump has called a reciprocal tariff, in which the US would raise its duties to match any tariff and non-tariff barriers faced by its exporters abroad (though including value-added taxes in the calculation is likely to fuel endless consternation). Retaliation announcements are a near-daily occurrence.
With the trade war looking as if it might drag on, policymakers will have to keep a watchful eye on consumer and market inflation expectations, since inflationary psychology can be self-fulfilling. Inflation has already been on the high side for the past four years, and the public is reluctantly getting used to the accelerated rate of rising prices — unlike the environment Trump faced during his first trade war. The University of Michigan’s measure of the median expected annual change in prices during the next five to 10 years is now 3.3%, the highest since 2008. Other measures of inflation expectations from Morning Consult and the Federal Reserve Bank of New York look comparatively tame. Policymakers will just have to stay on guard.
Of course, it’s basically a foregone conclusion that the Fed won’t announce any changes to its policy rate on Wednesday, so most of the attention will be on the so-called Summary of Economic Projections and Chair Powell’s press conference.
In the last SEP, published in December, the median among Federal Reserve Board members and regional bank presidents suggested that core PCE would end 2025 at 2.5%; unemployment would end the year around 4.3%; and the central bank would lower policy rates only twice to a range of 3.75%-4%. It’s possible that recent data will cause wiggles in those projections, but the Trump administration’s policies could very well render those tweaks meaningless over the next few months. Personally, I’ll be less focused on the median projections and more interested in the range of views. I also expect participants’ assessments of the uncertainty and risks around their projections to remain quite high.
In other words, anyone looking for answers from the central bank next week is likely to come away just as confused as before. If we can be confident of anything, it’s that the Fed finds itself essentially paralyzed by the circumstances, and it may not be much of a factor at all in the coming months.
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