No rate cut for a Trump-ravaged US economy — but the next best thing

The US Federal Reserve is now officially worried about the impact of Donald Trump’s tariffs, raising the possibility of stagflation as it lowers its growth forecasts for the American economy while revising up inflation forecasts.

As expected, there was no interest rate cut by the Fed in its meeting this week, but it is still flagging two more rate cuts this year and, crucially, is scaling back its “quantitative tightening” to support credit in an increasingly uncertain environment. This was all taken as good news by investors, with Wall St lifting on the announcement — despite the Fed revealing it now sees the US economy growing only 1.7% this year, much lower than the 2.8% rate for 2024 and the December forecast of 2.1%.

But it also boosted its inflation outlook, predicting core price growth of 2.8% annually, up from the previous estimate of 2.5%. It also expects unemployment will edge up to around 4.4% this year (from 4.1% in February) and remain unchanged over the next two years.

In its post-meeting statement, the Fed noted the “uncertainty around the economic outlook has increased”, adding that the central bank is “attentive to the risks to both sides of its dual mandate” (price stability and maximum employment).

Fed chair Jerome Powell acknowledged that a “good part” of the Fed’s new, higher inflation forecast has to do with tariffs. “Some of it, the answer is clearly some of it, a good part of it, is coming from tariffs,” he said during the post-meeting media conference. “But we’ll be working with other forecasters to separate non-tariff inflation [from] tariff inflation.”

Powell also said that while the Fed was getting “closer and closer” to price stability, the tariffs issue might lengthen the process. “I do think with the arrival of the tariff inflation, further progress may be delayed.” That puts the mad king front and centre for responsibility if further interest rate cuts are delayed.

While Powell pointed out that the Fed’s inflation estimates are “highly uncertain”, the so-called “dot plot” indicated that 19 Federal Open Market Committee members see the benchmark federal funds interest rate moving to 3.9% by the end of this year, within the target range of 3.75% to 4%. The rate was unchanged at the meeting, in a range between 4.25%-4.5%. That means two 0.25% cuts by the end of the year.

But in a sign the Fed thinks markets might become more stressed this year as uncertainty continues, the Fed said it would further scale back its “quantitative tightening” program, in which it is slowly reducing the bonds it holds on its balance sheet. It will now allow just $US5 billion in maturing proceeds from Treasury bonds to “roll-off” each month, down from $US25 billion. This leaves more cash in US markets — a form of insurance to calm nerves and signal the Fed will leave more money in the system in the event of liquidity strains. Call it $US20 billion of insurance a month. That’s quite a safety net, even for the US. The Fed is concerned.

How much attention will our economic policymakers — either in Canberra or at the Reserve Bank — pay to the significantly more uncertain outlook across the Pacific?

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