With President Trump's tough stance on trade policy, the Federal Reserve is facing a complex situation: should it take measures to curb inflation or prioritize support for economic growth?
The Trump administration is trying to use tariffs as tools of foreign and economic policy, but this creates a delicate balance for the Federal Reserve's policymaking. According to the Zhitong Finance APP, many economists believe that tariffs could raise prices while weakening GDP growth; the key issue is the extent of the impact and whether the Federal Reserve needs to make corresponding policy adjustments.
Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, pointed out that tariffs may lead to price shocks but could also be offset by a stronger dollar. However, in the long run, tariffs are generally adverse to economic growth. Jones stated, "This combination puts the Federal Reserve in a real dilemma."
Currently, the trade frictions between the Trump administration and China, Canada, and Mexico are ongoing. Although the plans for tariffs on Canada and Mexico have been temporarily suspended and negotiations are still underway, the trade dispute with China has escalated, resulting in heightened market tensions.
In the economics community, tariffs are generally seen as a factor that raises prices, but historical data has not provided clear evidence. For example, the Smoot-Hawley Tariff Act of 1930 not only did not lead to inflation but also exacerbated the deflationary pressure of the Great Depression.
Trump also implemented tariff policies during his first presidential term. At that time, inflation levels in the USA were low, and the Federal Reserve was raising interest rates to find a "neutral" interest rate level. However, tariffs triggered a manufacturing recession, although this impact did not spread to the entire economy.
But the current situation is different. The latest tariff policy proposed by Trump is no longer targeted at specific commodities but may cover a broader range of commodity categories, which could change the Federal Reserve's monetary policy calculations. Charles Schwab predicts that if these tariffs are fully implemented, GDP growth may decrease by 1.2%, and the core inflation rate may rise by 0.7%, surpassing 3% in the coming months.
Jones believes that such broad tariff measures "will have a greater impact on prices and a larger shock to economic growth." She predicts that the Federal Reserve may delay interest rate cuts due to the uncertainty of tariffs and may remain cautious in the face of rising inflation until economic growth begins to be significantly affected before adjusting its policy. "But the Federal Reserve is indeed in a difficult position now, as it is a double-edged sword."
Currently, the market generally expects that the Federal Reserve will keep interest rates unchanged in the coming months and observe the actual impact of tariff policies, rather than taking action solely based on policy statements. Furthermore, the Federal Reserve will assess the effect of a cumulative interest rate cut of 1 percentage point over the last four months of 2024.
If trade tensions ease, or if the impact of tariffs on inflation is less than expected, the Federal Reserve may refocus on its employment goal within its dual mandate, rather than concentrating on inflation issues.
"Currently, the Federal Reserve's policy stance is relatively firm, and the repeated issues surrounding tariffs will not directly change this stance, especially since we do not even know how these policies will ultimately be implemented," said Eric Winograd, Head of Developed Markets Research at AllianceBernstein. He expects that the specific impacts of tariffs will gradually emerge in the coming months, and the Federal Reserve's policy adjustments will not respond immediately.
Winograd believes that although tariffs may lead to a short-term increase in the prices of some Commodities, they will not bring the long-term inflationary pressure that the Federal Reserve usually focuses on. This perspective is also consistent with the recent statements from Federal Reserve officials. Federal Reserve officials believe that only when tariffs lead to a full-scale trade war or have a more profound impact on supply and demand will they truly affect monetary policy decisions.
Boston Fed President Susan Collins stated in an interview: "There is significant uncertainty in how policies will evolve, and we cannot precisely predict their effects without a clear understanding of the final policies." She emphasized that the Federal Reserve's position is "to remain patient and act cautiously, with no urgent need to further adjust policies at this time."
The market still expects the Federal Reserve to cut interest rates for the first time at the June meeting, potentially followed by a further 25 basis point cut in December. The Federal Reserve maintained the federal funds rate unchanged in the 4.25%-4.5% Range last week.
Winograd stated that the Federal Reserve could still cut rates two to three times this year, but will not initiate cuts immediately; instead, it will wait for the effects of tariff policies to become more apparent. He remarked, "Considering the overall resilience of the USA economy against trade friction, I do not believe that tariff issues will significantly change the Federal Reserve's policy direction. The market's expectations of how the Federal Reserve should react are overly mechanized—thinking that once inflation rises, the Federal Reserve must respond, which is not the case."
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