The Fed is about to run into an unstoppable force: Donald Trump

The Federal Reserve on Wednesday hit pause on interest rate cuts in its first key decision of President Donald Trump’s second term.

It’s a move that’s likely to stoke tensions between the central bank and the new president, who has argued that he should have some say in Fed policy.

Central bank officials opted to keep borrowing costs at a range of between 4.25% and 4.5% as they await further progress on inflation, which showed signs of stalling out late last year. Fed officials reached that conclusion in their latest policy statement, omitting a phrase included in the previous statement that said inflation has “made progress.”

Officials have said recently that they’re still confident inflation will eventually reach their 2% target, but the central bank won’t be able to declare victory anytime soon.

Economists are warning that Trump’s threat of stiff tariffs, plus mass deportation policies and the focus on boosting domestic oil production, could end up further stoking inflation, undoing some of the welcome progress the Fed has seen in recent years.

Even though the Fed is mulling a holding pattern that would delay further rate cuts, the central bank’s thinking on borrowing costs could shift if Trump keeps his promise of slapping 25% tariffs on Mexico and Canada, two of America’s biggest trading partners, on February 1.

Fed officials have likely already begun to consider potential changes in trade policy when determining their outlook for the economy. Many investors still expect the Fed to continue cutting interest rates this year, with a few estimating no rate cuts at all in 2025. But every possibility remains on the table, including additional rate hikes.

The Fed’s next move

Trump has promised big changes in economic policy: In addition to the massive tariffs he’s floated, Trump has also called for deregulation and extending his 2017 tax cuts — policies that economists describe as “expansionary.” That means they would likely boost economic growth, increasing the risk of a spike in inflation.

Trump’s ongoing crackdown on immigration could also have a massive impact on the labor market and the broader economy.

Put together, the new administration’s policies introduce some uncertainty because it’s not clear how the economy will ultimately respond to Trump’s shock therapy.

The Fed, which makes its decisions based on economic data, is tasked with making sense of this new economic landscape. Central bank officials, including Fed Chair Jerome Powell, frequently stress that their decisions are data dependent, and avoid commenting on fiscal policy. Powell has said the Fed considers fiscal policy as as given, adjusting monetary policy accordingly.

In late 2018 after the first Trump administration went on a tariff spree, the Fed devised multiple simulations to determine the best path for policy under different tariff scenarios, according to a declassified documents detailing policy alternatives known as the “tealbook.” In most scenarios, the Fed saw it appropriate to “see through” any tariff increases, considering that one-time tariff hikes usually translate to one-time price adjustments.

But in a scenario in which foreign countries enacted retaliatory tariffs and inflation expectations climbed, the Fed judged it appropriate to hike rates. Recent consumer surveys have shown an uptick in year-ahead inflation expectations.

For now, investors are betting that the Fed will also hold borrowing costs steady in March, though that expectation could change if future figures show that inflation slowed sharply in January and February.

This story is developing and will be updated.