May Meeting Unpacked
The minutes for the meeting on May 6-7, and indeed the public statements made by Chairman Jerome Powell subsequently, reveal a sense of distinct unease among the committee members.[1] At the time, the more extreme version of Trump’s tariff program was still in place, with additional charges of 145% on Chinese goods, amongst other measures.
The prospect of protracted tariffs was seen as likely to lead to both inflation (resulting from price hikes) and economic slowdown (as firms shed workers and scaled back growth plans). This combination, known as "stagflation", would put the Fed in a bind, as neither cutting nor lowering interest rates would be able to address both problems simultaneously.[2]
Hovering in the background, there is also the specter of the Fed’s misjudgment of the last spike in inflation, which it initially dismissed as temporary.[3] Chairman Powell indicated that the current ‘wait and see’ approach is likely to continue given that the costs of waiting to learn more about the economy are "fairly low".[4]
The Trade War Rumbles on
While framed as a war, the actual course of Trump’s "Liberation Day" tariffs is looking to be more a case of shadow-boxing. Shortly after the Fed’s May meeting, the U.S. negotiating team unexpectedly reached an agreement with the Chinese delegation in Geneva and saw the tariffs lowered from 145% to 30%.[5] Later in the month, a similar breakthrough occurred on the EU front, with the 50% tariff delayed until July.[6]
However, the picture is in a state of constant flux, with tariffs disappearing and threatening to re-appear with kaleidoscopic frequency and speed, and strained relationships with foreign powers constantly yielding contradictory signs.[7]
If, as some suspect, the tariffs are a means and not an end so far as Trump is concerned, this may well continue indefinitely, or until the Trump administration is satisfied it has reached a satisfactory position relative to the status quo ante.
This leaves observers - including the Fed - with little to do but “wait and see”.
The Rear-View Perspective
The Fed is fond of insisting that its views should be data-driven. The data in this case should in theory give grounds for optimism.
Both measures of inflation - the CPI, and the more important PCE - declined during April on a year-over-year basis, according to data released in May.[8] While headline PCE declined to 2.1%, Core PCE (excluding Food and Energy) reached 2.5%, its lowest reading since March 2021.[9] The very latest CPI figures show Core CPI declining a little further, leading some to declare that the Fed has beaten inflation.[10]
Employment, which constitutes the other half of the Fed’s mandate, is also apparently in a good place. Unemployment remained at 4.2%,[11] a historically low level, during April. GDP also seems to be in good shape, with the only unusual activity being the rush of pre-tariff orders by US entities.[12]
All of this is very well, critics may say, but current levels of uncertainty mean that past data may have little bearing on what is to come.
Conclusion
Fed officials have expressed differing views on how the year will end. Governor Christopher Waller believes that the tariff debacle will resolve into a baseline tariff of 15%, and that rate cuts are possible later in the year.[13] Other members, such as Dallas Fed president Lorie Logan, are more cautious about committing to lower rates at this point.[14]
Given that the Federal Reserve is itself divided on how events will play out, from our perspective it makes sense to avoid becoming overly enamored of any particular version of the future. Successful investing is not ultimately about predicting, but knowing when and how to react.