Cooler inflation last month leaves the door open for the Federal Reserve to resume cutting interest rates by mid-year, but the central bank remains worried that U.S. tariff hikes could rekindle price pressures, trigger an economic slowdown, or both.
As long as the labor market stays strong, continued easing on the inflation front would allow the Fed to adjust interest-rates slowly downward in what analysts and some Fed policymakers have referred to as "good news" rate cuts.
But February's data largely predates a burgeoning trade war that could stall progress on inflation and hurt the labor market, forcing the Fed to choose between keeping rates higher to tamp down price pressures or cutting them to cushion the labor market.
"We continue to think that underlying inflation is on a bumpy downwards trajectory ex-tariffs that would allow the Fed to deliver a good news inflation cut in June if the Trump administration moderates on tariffs and tariff uncertainty, and a bad news cut if the labor market weakens materially regardless of tariffs, provided that inflation expectations remain well anchored," wrote Evercore ISI's Krishna Guha.
Fed Chair Jerome Powell has said he wants to wait and see the economic effect of the entire suite of Trump policies, which also includes tax and spending cuts, deregulation and tighter immigration. The central bank is universally expected to maintain the policy rate in its current 4.25%-4.50% range at its March 18-19 meeting.
Traders of interest-rate futures are betting the Fed will make three quarter-point reductions in the policy rate by the end of 2025, starting in June.
This month President Donald Trump doubled income duties on goods from China to 20% and imposed 25% duties on all Canadian and Mexican imports, mostly on hold until April 2.
Increased tariffs on all steel and aluminum imports to the U.S. went into effect on Wednesday, drawing retaliatory tariffs from Canada and the EU. All of that will likely mean higher prices paid by consumers, analysts say, even if importers absorb some of the cost increases themselves.
Consumer inflation expectations have also surged, worrying Fed policymakers who say that a belief that prices will rise can too easily translate into actual higher prices.
At the same time, higher tariffs, the retaliatory actions of U.S. trading partners, and the pall of uncertainty cast by Trump's erratic trade policy is already slowing business activity, surveys show, threatening to cool a labor market that has so far remained strong.
"Tariff uncertainty and associated price increases will squeeze spending power and could prompt further weakness in consumer sentiment and spending," ING economists wrote. "They may also mean that the lack of clarity on the trading environment and the threat of reciprocal tariffs weighs on corporate sentiment, holding back on investment and hiring until there is greater clarity – hence the growing talk of potential recession."
Data due Thursday on wholesale prices should help analysts pin down what Wednesday's consumer price data means for inflation by the measure the Fed targets at 2%, the year-over-year personal consumption expenditures (PCE) price index.
Some analysts said the details of the consumer price report suggest PCE inflation could actually have worsened in February.
