Washington
CNN
—
Late last year, it seemed like the Federal Reserve had pulled off the unlikely — tamping down the highest inflation in four decades without triggering a recession, an outcome known as a “soft landing.” Now, two months into President Donald Trump’s second term, that historic win could be reversed as a global trade war looms.
Since Trump took office in January, his administration has overhauled trade policy, slashed the federal workforce, clamped down on immigration and reconfigured America’s relationship with its allies — structural changes that have put American consumers, businesses and investors on edge. During that time, major stock indexes went from hitting record highs to slipping into correction territory and consumer sentiment went from an eight-month high to its lowest level since November 2022.
Now, Fed officials face the difficult task of figuring out how the economy will ultimately respond to Trump’s shock therapy. Analysts have already pointed to higher inflation and weaker growth this year, a toxic duo resembling “stagflation.”
Central bankers are almost certain to hold interest rates steady at the conclusion of their March meeting on Wednesday, and Fed Chair Jerome Powell will likely reiterate that the economy remains in decent shape, but their latest projections will probably show the economy is trending toward stagflation, economists say.
Powell’s tough job is to now communicate to an anxious America how the Fed will handle that looming twin threat, as various surveys show Americans’ perceptions of prices are changing for the worse.
“It’s hard to say how these opposing forces will balance out in the end, and that’s what the Fed is having to consider right now,” Tom Bruce, macro investment strategist at Tanglewood Total Wealth Management, told CNN. “They’re data dependent, so they’re not making any moves at this meeting, but Powell will have to express that they’re watching the situation closely and staying prepared to make a policy change if necessary.”
Before Trump took office, there were already signs that inflation’s descent was stalling out, which was a big reason why the Fed stopped cutting interest rates in January. The Fed’s solution for that was simple: Stand pat until inflation slows again.
January’s decision wasn’t hard because the economy looked to be in good shape, with low unemployment and steady growth. Fed officials may not have that luxury for much longer.
Trump’s tariffs could not only jack up prices, but they could also hamper growth. Global economists at the Organisation for Economic Co-operation and Development said Monday that “the new bilateral tariff rates will raise revenues for the governments imposing them but will be a drag on global activity, incomes and regular tax revenues.”
Trump promises his administration will match the tariffs foreign countries impose on the United States on April 2. The tariffs his administration has already rolled out, such as on metals and Chinese goods, were met with swift retaliation.
The ongoing trade spat comes at a time when the mighty American consumer, the engine of the US economy, might be pulling back: Retail sales, which account for a third of overall spending, were much weaker than expected in February. Consumer spending dropped off in January during unusually harsh cold weather, which is expected to drag on economic growth in the first three months of the year.
“A lot of what we’re contending with is in the inflationary direction, but we’re also expecting to see a moderation in consumer spending, coming from the fact that the jobs market is continuing to cool off,” said Sarah House, senior economist at Wells Fargo.
Americans aren’t only skittish, but they may also be losing faith that inflation will eventually return to normal in the long run.
Fed officials pay close attention to people’s perception of prices because they can be self-fulfilling. If people expect inflation to ratchet higher, and remain elevated in the coming years, then they can modify their spending accordingly. Inflation expectations that are “un-anchored” make it difficult for the Fed to do its job.
Americans’ expectations for inflation in the year ahead climbed to 4.9% this month from 4.3%, the highest level since November 2022 “and marking three consecutive months of unusually large increases of 0.5 percentage points or more,” according to the University of Michigan’s latest consumer survey.
Meanwhile, Americans’ expectations for inflation in the next 5 to 10 years surged to 3.9% in March from 3.5% in February, the Michigan survey said, which was “the largest month-over-month increase seen since 1993.”
Several Fed officials have said that they would be worried if long-run inflation expectations begin to climb. That could force the Fed to consider hiking interest rates, even if it means unemployment rises.
“These days, higher tariffs and immigration policies are often discussed and thought likely to increase prices, cool aggregate demand and possibly soften employment. From the standpoint of monetary policy, it could be appropriate to ignore or look through an increase in the price level if the impact on inflation is expected to be brief and limited,” St. Louis Fed President Alberto Musalem said last month at an event in New York.
“However, a different monetary policy response could be appropriate if higher inflation is sustained, or long term inflation expectations rise,” he said.
The Fed is expected to announce its latest decision on rates at 2 p.m. ET Wednesday, followed by a press conference with Chair Powell at 2:30 p.m. ET.
