Interest Rates Are Likely to Remain Unchanged, but 'Bad News Cut' Are More Likely in the Fall

The Federal Reserve is widely expected to keep its benchmark interest rate unchanged at its upcoming meeting as it takes a "wait and see" approach amid concerns that President Donald Trump’s tariff policies could simultaneously drive up inflation and slow economic growth.

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A key challenge for the Fed will be determining whether it should look past the anticipated inflation surge and cut rates as markets expect, or if it should hold steady until it is confident that inflationary pressures will be temporary, according to Diane Swonk, chief economist at KPMG.

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Former Boston Fed President Eric Rosengren told MarketWatch that he now anticipates economic weakness later this year, which could prompt both hawkish and dovish Fed officials to agree on one or two rate cuts in the fall. Initially, Rosengren assumed that tariffs would not have a major impact and expected no policy changes.

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However, he now foresees a sufficiently weakened economy that will require monetary easing, albeit “for the wrong reason.” He estimates the U.S. economy will grow at just a 1% annual rate this year and places the likelihood of a recession at around 30%, compared to the usual 15%.

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So far in 2024, the Fed has kept its benchmark interest rate within a range of 4.25% to 4.5% following 100 basis points of rate cuts. However, it cannot lower rates preemptively due to persistent inflation, which has been hotter than expected this year. Additionally, inflation expectations, as tracked by the University of Michigan, have risen sharply.

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With inflation remaining high, the Fed will be more reactive than proactive, meaning it won’t cut rates at the first signs of economic weakness, according to Robert Kaplan, former Dallas Fed president. Fed Chair Jerome Powell maintains that current rates are "restrictive" enough to gradually bring inflation down. At some point, this stance will allow room for cuts, said Tim Duy, chief economist at SGH Macro Advisors.

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Krishna Guha, vice chairman of Evercore ISI, noted that while the upcoming Federal Open Market Committee (FOMC) meeting is expected to be uneventful, there is an unusual level of risk for market reactions. Powell has attempted to buy time by suggesting that the Fed does not need to rush into action. “The costs of being cautious are very, very low. The economy’s fine. It doesn’t need us to do anything, really, and so we can wait and we should wait,” Powell said in his last speech before the Fed meeting.

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Powell also stated that the central bank is assessing the broader impact of Trump’s policy changes across four key areas: trade, immigration, fiscal policy, and regulation. Economists agree that evaluating these factors will be difficult. Duy expects Powell to take a near-term hawkish stance but not discourage market participants from anticipating rate cuts later this year.

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Vince Reinhart, chief economist at BNY Investments, warned that investors might be disappointed if Powell's remarks carry a hawkish undertone. In December, the Fed projected two rate cuts for 2024, and that forecast is unlikely to change in this week’s updated economic outlook. The Fed will release its policy statement and revised economic projections at 2 p.m. on Wednesday.

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Former Fed Vice Chairman Roger Ferguson said he does not expect the central bank to adjust rates in May. “If the market is anticipating a cut at the next meeting, they’re probably going to be disappointed,” he told CNBC.

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Traders in derivatives markets currently anticipate three quarter-point rate cuts this year, beginning in June. Luke Tilley, chief economist at Wilmington Trust, believes the Fed is trying to avoid changes unless the data forces its hand. “If the economy is not collapsing and inflation is not surging, the best thing they can do is hold steady,” he said.

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Recent retail sales data for February has eased concerns that the economy is already contracting, giving the Fed additional time to assess how it should respond to the president’s economic policies. Analysts believe that while early indicators of a slowdown will be closely watched, it is still too early for the central bank to take action.

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Trump’s proposed tariffs are expected to push prices higher in the short term, but they may also weaken the economy and ease inflationary pressures next year. The Fed’s preferred inflation measure—the personal consumption expenditures (PCE) price index—has declined from its peak above 7%, but inflation remains stubborn, running at an annual rate of 2.5%.

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According to Torsten Slok, chief economist at Apollo Global Management, the proposed tariffs could add approximately 0.5 percentage points to core PCE inflation, keeping it near 3%, a level that many Fed officials consider uncomfortably high.

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Claudia Sahm, chief economist at New Century Advisors and a former Fed staffer, agrees that the Fed is unlikely to cut rates unless there are clear signs of economic distress. She believes the central bank will either maintain its current stance or, in the event of significant labor market deterioration, initiate an aggressive rate-cutting cycle. “If the slowdown is severe enough, even the hawks will support rate cuts,” she said.

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Tilley at Wilmington Trust predicts a total of 100 basis points in rate cuts this year. He argues that consumers are not in a strong position and that tariffs function as a substantial tax increase, which will drag down economic growth.

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Meanwhile, James Egelhof, chief U.S. economist at BNP Paribas, expects the Fed to remain on hold until 2026. He forecasts that economic growth will bottom out at below 1% in the third quarter, with inflation peaking at 4% in the fourth quarter.

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