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Uncertainty about President Donald Trump’s tariffs is complicating the “data-dependent” US Federal Reserve’s efforts to send a clear message about the direction of the economy, economists say.
As the Fed prepares to deliver its latest interest rate decision on Wednesday, figures last week showed inflation slowed more than expected in February, bolstering the case to resume cuts later this year amid signs of slowing growth.
However, policymakers are also weighing fears that promised trade tariffs could stoke inflation or trigger an economic slowdown — or both.
“The promise of future tariffs essentially pushes aside [the Fed’s] goal of data dependency and means they’re going to have to rely more on a forecast framework,” said Joe Brusuelas, chief economist at tax and consulting firm RSM US.
Although the US central bank is widely expected to keep interest rates on hold this week, investors will be scrutinising officials’ economic forecasts, which show how they are thinking about interest rate levels for the coming years, as well as chair Jay Powell’s post-meeting statement.
The Fed has in recent years insisted that it is “data-dependent” and focuses more on the latest inflation and growth figures rather than modelling the future. This stance became increasingly prominent as the central bank sought to maintain its credibility after failing to forecast surging inflation in 2021 and 2022.
Policymakers say a dependence on data helps them to stay flexible. Some economists, however, fear that reliance on backward-looking data will put the central bank on the back foot in an environment of increased political and economic uncertainty, especially as expected tariff-induced price pressures could take some time to filter through to the data.
February’s surprisingly cool inflation figures, in particular, will make Fed chair Jay Powell’s messaging “more awkward” because it will “be harder to point exclusively to the data” to justify holding interest rates steady, and even potentially raising future forecasts on Wednesday, said Vincent Reinhart, chief economist at BNY Investments.
He added that the latest inflation report was “a rear-view mirror reading” that was too early to capture the impact of Trump’s proposed trade levies. A 10 per cent tariff on Chinese imports only went into effect partway through the month and may not yet have trickled through to consumer prices, while levies on Mexico and Canada were pushed back to April 2.
Brusuelas said the Fed was facing “a difficult policy position” because raising tariffs on some of the country’s biggest trading partners could simultaneously increase price pressures and weaken the US jobs market, each of which would support opposing interest rate decisions.
Trump’s shifting economic policies may also affect how policymakers weigh different economic indicators, according to Thomas Ryan, North America economist at Capital Economics. He expects to see less focus on the price level — a “backward-looking” metric of inflation — and more emphasis on consumers’ inflation expectations, which have begun to tick up since the start of the year.
On Wednesday, Fed officials will also be weighing a disappointing employment report, which showed that the economy created 151,000 new jobs in February, fewer than expected, adding to fears of slowing growth. In a speech last Friday, Powell played down these concerns, insisting that the economy remained “in good shape” despite “elevated levels of uncertainty”.
But that uncertainty — the result of multiple U-turns on economic and trade policy — means that the Fed will be left “on the back foot” and “unable to plan or take a strong position”, according to James Knightley, chief international economist at ING.
The administration’s dizzying policy changes have already sparked an equity market sell-off and concern from businesses.
Major US airlines American, Delta, and Southwest this week warned of a slowdown in demand spurred by consumer uncertainty about the US economic outlook. Wall Street’s benchmark S&P 500 stock index, meanwhile, fell into correction territory last week before inching back.
“We know for sure that everybody — businesses, households, and monetary policymakers — hates uncertainty,” said David Wilcox, a former Federal Reserve member of staff who now works at the Peterson Institute for International Economics and Bloomberg Economics.
Beyond an “oblique reference” to the challenges of uncertainty, however, Wilcox said that Fed officials would try to avoid making any specific reference to Trump’s economic agenda.
“Overwhelmingly, I suspect one of Powell’s key objectives will be to keep his head down and not be perceived as providing any running commentary on administration policy,” he said.
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