Fed holds rates steady, keeps door open to cuts

Officials are waiting to see if businesses manage higher costs from tariffs by trimming profits or pushing up prices

Jerome Powell, chairman of the U.S. Federal Reserve. Picture: Getty Images via AFP

Federal Reserve officials left the door open to cutting interest rates in the second half of the year when they agreed to hold rates steady Wednesday.

President Trump pre-emptively blasted the widely anticipated rate decision earlier in the day and called for much more dramatic cuts of between 1 and 2.5 percentage points. The Fed left its policy rate in a range between 4.25 per cent and 4.5 per cent.

To resume rate cuts that they started last year, Fed officials are likely to need to see either labour markets soften or stronger evidence that price increases due to tariffs will be relatively muted. Projections released Wednesday suggest officials were open-minded about whether they would have that evidence by the fall.

The new interest-rate projections highlighted a divergence among the 19 Fed officials who participated in the meeting. Ten of them expect the central bank to cut rates at least twice this year, a narrower majority than in March, and two pencilled in one cut. Meanwhile, seven pencilled in no changes this year, up from just four in March.

Economic projections show officials expect inflation and unemployment to rise this year by more than they projected in March. That is a potentially messy combination for a central bank because it could force officials to choose between focusing on shoring up the labour market by lowering interest rates or defending against higher inflation by keeping rates where they are.

Officials indicated they expected a closely watched measure of inflation to rise to 3.1 per cent this year; it was 2.5 per cent in April. They projected the unemployment rate, at 4.2 per cent in May, would creep up to 4.5 per cent by the end of the year.

Officials made only minimal changes to their policy statement. Fed Chair Jerome Powell is set to answer questions from reporters at a news conference on Wednesday at 2:30pm. Eastern time.

Wednesday’s projections were the first since Trump’s large “Liberation Day” tariff announcements on April 2. While Trump later suspended the largest tariff hikes, broad increases in import duties have raised US tariff rates this year to their highest levels since the 1930s, according to the Yale Budget Lab.

Speaking to reporters at the White House before the Fed meeting, Trump unloaded on Powell. “We have a stupid person, frankly, at the Fed,” Trump said, continuing his drumbeat of name-calling that followed an Oval Office meeting between the two men last month.

“I’m nasty. I’m nice. Nothing works,” Trump said.

President Trump has repeatedly called on the Federal Reserve to cut interest rates, including earlier Wednesday. Picture: AP /Evan Vucci

Trump said he wanted big rate cuts so that it will be easier for the US Treasury to issue less expensive long-term debt. If the Fed’s inflation worries come true, then the Fed could raise rates, Trump said.

Powell, whom Trump appointed in 2018, has a term that ends in a year, and Trump said he expected the Fed to drop rates after he replaces Powell next year. Fed decisions are the product of extensive deliberation between the seven presidentially-appointed Fed governors and a rotating group of five regional bank presidents.

Currently, the Fed doesn’t set interest rates with an eye on helping manage federal borrowing expenses and instead is focused on maintaining low and stable inflation with a sturdy labour market.

The Fed is on hold because it sees risks no matter what it does. Inflation has declined close to — but hasn’t quite reached — the Fed’s 2 per cent goal after four years running above the target.

Cut rates too soon, and the Fed risks reigniting inflation. Many economists expect businesses to raise prices due to higher import costs, and rate cuts could fuel more economic activity at the wrong time. The Fed doesn’t want to be in a situation where, one year from now, inflation has jumped back above 3 per cent and stayed there.

Wait too long, and economic uncertainty plus rising costs from tariffs could squeeze company profits, leading to lay-offs and a recession. The housing market has slowed of late, a sign that higher borrowing costs remain a headwind in rate-sensitive parts of the economy.

Among Fed rate-setters, “the vast majority are first and foremost worried about inflation right now, before they’re worried about a potential slowdown,” Fed governor Adriana Kugler said earlier this month.

The Fed has additional reason to stay on hold, with conflict in the Middle East threatening to reverse recent declines in energy prices. The uncertainty alone reinforces the case for caution by layering one supply shock onto the other, tariff-driven shock.

Many economists expected tariff-driven price increases would appear soon after implementation, but May inflation data was surprisingly mild.

While inflation can be volatile from one month to the next, and basing conclusions on one month can be risky, some analysts say it hints at how tariffs may hurt businesses more than they drive up consumer prices.

“Were you collecting tariff revenue in May? Yes. Inflation came out weaker. Is there information there? Yes,” said Neil Dutta, economist at Renaissance Macro. “It doesn’t mean tariffs are having no effect on prices, but it suggests the demand shock is outweighing” the sudden increase in production costs.

The Fed remains cautious due to the uncertain impact that new tariffs could have on inflation. Picture: Getty Images via AFP

If companies can’t pass higher costs to consumers, their profits suffer. “This looks like a margin squeeze. Companies are working on managing that squeeze, and that means unemployment will go up,” Dutta said.

While the unemployment rate has remained at a relatively low level this year, some data point to softness in the labour market. The number of people collecting unemployment benefits for an extended period is near a three-year high. Job growth has been revised down in recent months. Economists pay attention to larger revisions because they can precede broader hiring slowdowns.

For the Fed, a cooling job market could help with inflation by reducing wage pressures and consumer spending power. “The question will be, ‘How much resistance do businesses meet to cost increases,’ and that will depend on how much weakening there is in the labour market,” said Donald Kohn, a former Fed vice chair.

Despite concerns about economic weakness, financial conditions outside of housing suggest money remains relatively easy to find. Credit spreads — the extra interest companies pay over government bonds — are tight. Corporate bond issuance is healthy, and bank lending continues to grow.

Stock markets remain near all-time highs despite widespread forecasts for slower economic growth. In addition, companies that have added stablecoin-related payment technologies to their business models have seen their stock prices surge — a sign that speculative capital remains abundant.

Buoyant financing conditions could make it harder to justify cuts.

Stock markets remain near all-time highs despite widespread forecasts for slower economic growth. Picture: AFP

The Fed is apprehensive not just about the magnitude of any price increases, but also about how tariff announcements could disrupt what economists refer to as “inflation expectations.” Economic theory suggests those expectations can be self-fulfilling because consumers and businesses behave in ways that lead to more inflation.

The fear that inflation expectations might become unmoored has lingered because of the high-profile and fluid nature of Trump’s tariff announcements. Businesses subject to tariffs have reported they will attempt to pass along price increases, and some firms that aren’t subject to tariffs have indicated they may try to raise prices if their competitors do.

“We’ve just come through a generationally bad episode of inflation, and that undoubtedly has undermined confidence among businesses and households that the Fed has the capability to control inflation on a precise basis over a near-term period of just a year or two,” said David Wilcox, an economist at Bloomberg Economics and the Peterson Institute for International Economics.

“That lack of confidence makes the inflation process more fragile so that it will take less in the way of a shock…to move actual inflation up,” Wilcox said.

Wall Street Journal