An Uncertain Economic Moment Poses a Big Test for the Fed

Just days after President Trump secured victory in the 2024 election, Federal Reserve Chair Jerome H. Powell carefully sidestepped a question about how the central bank planned to address the challenging mix of high inflation, slowing growth, and rising unemployment.

“Our goal is to avoid stagflation altogether,” Powell told reporters. “So far, knock on wood, we haven’t seen a significant deterioration in the labor market.”

Four months later, however, Trump’s aggressive tariff policies, deep federal budget cuts, and the resulting turmoil in financial markets have placed the Fed in an increasingly difficult position.

Although full-scale stagflation remains an unlikely scenario—given the solid foundations of the U.S. economy—what once seemed like a historic soft landing, in which the Fed could rein in inflation without derailing economic stability, now appears increasingly fragile.

As the Fed concludes its policy meeting on Wednesday, it is widely expected to maintain interest rates at 4.25 to 4.5 percent. Powell has recently downplayed the need for immediate adjustments to borrowing costs, emphasizing that the central bank is focused on “distinguishing meaningful trends from temporary fluctuations” when assessing the Trump administration’s policies. With the economy still stable, he said, the Fed is “well-positioned to wait for greater clarity.”

However, if economic cracks begin to show and inflationary pressures mount—something consumers are growing increasingly anxious about—the Fed’s policy decisions will become far more complex, potentially placing it directly in Trump’s line of fire.

“The Fed is in a real bind,” said Mahmood Pradhan, head of global macro at the Amundi Investment Institute. “It has no control over the broader policy environment, no control over uncertainty, and no control over the volatility created by the tariff debate. It’s a very tough hand they’ve been dealt.”

Fed officials have become skilled at avoiding direct commentary on Trump’s policies. But the sheer number of actions taken in just the first two months of his second term has made this increasingly difficult.

The flood of tariff threats alone has significantly widened the range of potential economic outcomes, unsettling even the most optimistic forecasters. Economists are also grappling with the severe spending cuts implemented by Elon Musk and his Department of Government Efficiency, as well as the potential deportation of millions of immigrants.

Trump’s reluctance to dismiss the possibility of a recession—combined with a shift in rhetoric from his top advisers about the potential economic pain required to achieve his promised boom—has fueled concerns about just how far the administration is willing to go. Those fears intensified last week when Trump dismissed economic warning signs, unsettling financial markets.

There are already signs that uncertainty surrounding tariffs is having a tangible effect. Consumer sentiment declined for the third consecutive month in March, according to preliminary data from the University of Michigan.

Mentions of tariffs on corporate earnings calls have surged, according to FactSet, with executives increasingly warning of weaker demand and rising costs. Confidence in the job market is also eroding, as more consumers surveyed by the Federal Reserve Bank of New York anticipate higher unemployment and worsening financial conditions in the near future.

“Consumption, which has driven U.S. economic growth in recent years, is losing momentum,” said Marc Giannoni, chief U.S. economist at Barclays and a former researcher at the Fed’s regional banks in Dallas and New York.

Last week, Giannoni’s team slashed its growth forecast for the U.S. economy by nearly a full percentage point, bringing it down to 0.7 percent for the fourth-quarter-over-fourth-quarter measure. JPMorgan and Goldman Sachs also revised their estimates downward, citing tariffs and the expectation that heightened trade uncertainty will deter investment and hiring.

A particularly troubling development is that they made these downward revisions while simultaneously raising their inflation forecasts. Companies are bracing for higher costs due to Trump’s tariffs on imports, and many are signaling that these increases will be passed on to consumers.

Tom Madrecki of the Consumer Brands Association noted that major food companies represented by his trade group—such as PepsiCo, General Mills, and Conagra Brands—could face challenges if tariffs are imposed on ingredients that cannot be easily sourced domestically.

“There’s no way to win in this scenario,” he said. “Grocery prices are bound to rise, but at the same time, consumers have already reached their breaking point.”

The trade group recently sent a letter to Trump requesting exemptions for products such as coffee, cocoa, and oats, which are primarily imported.

Madrecki argued that such exemptions would help companies avoid absorbing additional costs, which, he said, “won’t contribute to job growth or continued investment in new facilities.”

Americans are already adjusting their expectations accordingly. Inflation expectations have climbed sharply—both for the coming year and over a five-year horizon. Some economists caution against reading too much into these shifts, partly because of the increasingly partisan nature of survey responses. Market-based indicators have remained stable, even as consumer surveys have reflected greater concern.

However, the growing divergence in expectations itself is a warning sign.

“There is widespread disagreement about where inflation is headed,” said Yuriy Gorodnichenko, an economist at the University of California, Berkeley. “In practical terms, this means inflation expectations are unanchored. People’s beliefs about future inflation can swing dramatically because uncertainty is so high.”

The trajectory of inflation expectations will be crucial in shaping the Fed’s policy approach. Historically, the central bank has argued that it can overlook tariff-driven inflation, as such price increases are often temporary. In response to economic concerns triggered by the last major trade war during Trump’s first term, the Fed cut interest rates in 2019.

This time, however, the Fed may have less flexibility. Inflation remains above the 2 percent target, limiting the central bank’s ability to ease policy in response to a slowing economy. Powell has indicated that the Fed’s response to tariffs will depend on “the persistence of inflationary effects and the trajectory of long-term inflation expectations,” reinforcing that price stability remains the priority.

Jon Faust, who advised Powell until last year, emphasized the Fed’s central challenge: “The one thing that absolutely cannot happen is inflation rising alongside inflation expectations, because that would be the worst-case scenario—one that the Fed cannot allow.”

Adding to the complexity is Trump’s willingness to test the Fed’s political independence. While he has refrained from publicly attacking Powell as frequently as he did during his first term, he has taken more direct steps to exert influence over the central bank through executive orders.

“President Trump seems even less bound by traditional norms than before,” said Faust, now at the Center for Financial Economics at Johns Hopkins University. “If the economy slows and tariffs drive inflation higher, tensions between the Fed and the administration could escalate quickly. That’s a recipe for a serious confrontation.”