This is how Trump’s tariffs will affect interest rates according to the Fed

Although President Donald Trump has rolled back many of the tariffs initially imposed on Canada and Mexico, some remain in effect—creating an added layer of uncertainty as the Federal Reserve weighs its next interest rate decision.

The Federal Open Market Committee (FOMC), which sets the Federal Funds Rate—the benchmark rate that influences loans and financial products—will meet next week. While the FOMC cut rates in late 2024, bringing the effective FRR down to 4.33%, from the recent high of 5.33% reached in August 2023. With economic uncertainty weighing on consumers, investors, and businesses, another rate cut seems increasingly unlikely. Here’s why.

A week of flip-flopping from the White House bred anxiety on Wall Street

Despite scaling back some tariffs, the administration has maintained 20% duties on most Chinese imports. Additionally, ABC News estimates that around half of Mexican imports and nearly 60% of Canadian imports remain subject to 25% tariffs. Another wave of tariffs could take effect on April 2, when the White House plans to impose reciprocal duties on additional trading partners.

These policy shifts have unsettled Wall Street. The stock market tumbled last week following mixed signals from the White House, and investors are bracing for more volatility. On Monday, the S&P 500 fell 2.7%, while the Dow Jones Industrial Average and NASDAQ Composite dropped 2.08% and 4%, respectively. All three major indices remain in the red since Trump took office. While the president has claimed he isn’t concerned with market fluctuations, last week’s abrupt reversals—coinciding with market downturns—suggest otherwise.

Federal Reserve’s perspective: A wait-and-see approach

From the Fed’s standpoint, caution is key as economists assess the impact of current and expected Trump administration policies. The central bank will focus on key indicators such as inflation, employment, consumer confidence, and investor sentiment.

In a speech on March 7, Fed Chair Jerome Powell acknowledged the administration’s swift policy changes, emphasizing that the central bank is monitoring their overall effect.

“It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy,” Powell stated, adding that the FOMC is “focused on separating the signal from the noise as the outlook evolves.”

While the immediate impact on interest rates remains uncertain, Powell made it clear that the Fed sees no urgency to act, concluding that policymakers are “well positioned to wait for greater clarity.”

Fed Chair Jerome Powell has emphasized the need to balance the central bank’s dual mandate: keeping inflation near 2% while fostering conditions for full employment. The latest February Employment Report, released last Friday by the Bureau of Labor Statistics (BLS), showed a slight increase in the unemployment rate to 4.1%. While thousands of federal layoffs contributed to this uptick, job gains in other sectors helped offset deeper losses. However, if businesses begin scaling back operations due to recession fears and weakening consumer demand, unemployment could rise further.

The relationship between tariffs and inflation

Tariffs—though President Trump has been reluctant to acknowledge it—can drive inflation. While the initial tariff costs are paid by importers, they are typically passed along to domestic buyers and, eventually, to consumers. The speed at which price increases are felt depends on the type of goods affected. Agricultural products from Mexico, for example, could see immediate price hikes, while automobiles—subject to tariffs at the manufacturing stage—may not reflect higher costs for several months.

This Wednesday, the BLS will release the February Consumer Price Index (CPI), offering a clearer picture of how the latest tariffs are affecting prices. Additionally, the Producer Price Index (PPI) will provide insight into cost pressures faced by businesses. If both reports show significant price increases, the Federal Open Market Committee (FOMC) will likely keep interest rates steady rather than cutting them.

“The path to sustainably returning inflation to our target has been bumpy, and we expect that to continue,” Powell warned last week. With economic uncertainty mounting, the Fed appears poised to take a cautious approach, prioritizing stability over immediate rate cuts.

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