Federal Reserve policymakers worry U.S. President Donald Trump's trade policy could deal a blow to economic growth, but are signaling they won't be quick to ride to the rescue with interest rate cuts because they expect increased tariffs to boost inflation.
"Risky" is how both St. Louis Fed President Alberto Musalem and Minneapolis Fed President Neel Kashkari described treating tariff-driven price hikes as one-time events that central bankers can safely ignore.
Musalem and Kashkari are the latest Fed policymakers to express concerns that the expected price increases from the tariffs that have been announced, along with retaliation by other nations, could potentially translate into more persistent inflation that would require tighter monetary policy. At the same time, they worry that slowing growth could raise unemployment, a situation the Fed would otherwise want to counter with easier monetary conditions.
That scenario could force a choice about which goal to emphasize at the expense of the other, a point policymakers including Fed Chair Jerome Powell have been highlighting in recent remarks and particularly since Trump on April 2 unveiled tariffs far beyond what investors and Fed officials anticipated.
Minutes of the Fed's March 18-19 meeting released on Wednesday showed policymakers even then were worried about the "difficult tradeoffs" they could face if inflation proves persistent but growth also slows.
On Wednesday, after days of stock market turmoil and surging Treasury yields highlighted investor worries about a potential recession, Trump abruptly changed course, announcing that he will ratchet up tariffs on China but also put in a 90-day pause on most of the big levies he had announced on imports from other countries just a week earlier.
The turnaround served to underscore another message that Fed policymakers have also hammered home in recent weeks - with so much unclear about the actual policies of the Trump administration, let alone their effects, the Fed is firmly in wait-and-see mode.
"If you're driving in really dense fog, there are two things you don't want to do. And one is to step on the gas because you don't know who's in front of you. And one is step on the brake because you don't know who's behind you" Richmond Fed President Thomas Barkin told the Economic Club of Washington, D.C., unaware that while he was fielding questions from the audience the ground had shifted yet again.
After Trump delivered his temporary tariff reprieve for most countries, U.S. stocks surged and financial markets pulled back on earlier bets on aggressive Fed rate cuts.
BELOW-TREND GROWTH
Still, as Barkin and other Fed officials said, the direction of the new administration's policies is clear, even if the destination isn't, and as policymakers map out their options, they do not see a clear path to a soft landing, in which inflation slows without a damaging recession or sharp rise in unemployment. That scenario last year seemed increasingly in reach.
As firms and households adjust to prices driven higher by the new import levies, economic growth will likely slip "materially" below trend and the unemployment rate will rise over the year, Musalem told Reuters in an interview.
"I don't have a baseline of recession," he said, but "I'm thinking growth is probably going to come in materially below trend," which he estimated at around 2%.
"You're getting risk on both sides materializing," with higher-than-anticipated tariffs putting pressure on prices as declining confidence, a blow to household wealth from the recent sharp drop in equity markets that could depress spending, and the impact of higher prices all combine to slow growth, Musalem said.
How monetary policy responds will depend on how inflation and unemployment evolve in the coming months, whether the price shock appears to be persistent, and whether inflation expectations remain consistent with the Fed's 2% inflation target, said Musalem, who is a voting member of the Fed's policy-setting committee this year.
Kashkari said "the hurdle to change the federal funds rate one way or the other has increased due to tariffs."
Given how critical it is to keep expectations for ever-higher prices from getting embedded in the mindset of Americans, "the bar for cutting rates even in the face of a weakening economy and potentially increased unemployment is higher," Kashkari said in an essay released by his regional Fed bank. But given the likely drop in investment also due to the tariffs, he said, "policy is getting somewhat tighter on its own, reducing the immediate need to raise the federal funds rate to keep long-run inflation expectations anchored."
The Fed's policy rate has been in the 4.25%-4.50% range since last December. Until Trump's surprise announcement on Wednesday, markets had been betting heavily that the central bank would respond to the tariffs with a series of rate cuts starting next month.
