An aggressive suite of tariffs announced Wednesday by President Donald Trump will significantly complicate the Federal Reserve’s job as it struggles to quash inflation and avoid an economic downturn, likely keeping officials in wait-and-see mode.
“They’re basically our worst-case scenario,” said Diane Swonk, chief economist at KPMG, who said the tariffs raised the likelihood of an economic slowdown in the U.S.
But Swonk and other economists said Fed officials will likely hold off on lowering rates to cushion the economy while they assess the potential impact of the tariffs on inflation.
The levies, which are harsher than many analysts were anticipating, are expected to raise prices on trillions of dollars in goods imported each year if left in place. A full blown trade war, with escalating retaliatory tariffs between the U.S. and other countries, could disrupt supply chains, reignite inflation and worsen a souring economic outlook.
Trump said Wednesday the U.S. would apply a minimum 10% levy on all imports to the U.S., but tariffs on many countries will far exceed that. China’s cumulative effective rate is estimated to exceed 50%. The European Union will have a 20% levy and Vietnam is seeing a 46% tariff.
Bloomberg Economics estimated the new levies could lift the average effective tariff rate in the U.S. to around 22%, from 2.3% in 2024. Omair Sharif, president of Inflation Insights LLC, calculated a level of 25% to 30%.
For Fed officials still working to rein in the price gains that spiked during the pandemic, however, the inflationary fallout from the president’s actions may limit policymakers’ ability to step in and bolster the economy.
Fed Chair Jerome Powell is scheduled to speak at a conference Friday in Arlington Virginia.
“It puts the Fed between a rock and a hard place,” said Jay Bryson, chief economist for Wells Fargo & Co. “On the one hand, if growth slows and the unemployment rate comes up, they want to be more accommodative, they want to be cutting rates. On the other hand, if inflation goes up from here, they kind of want to be raising rates. So it really puts them in a tough spot.”
Joseph Brusuelas, chief economist at RSM US LLP, agreed the new regime was far tougher than many analysts expected and will raise the probability of a US recession.
“I expect inflation into 3% to 4% range by the end of the year,” he said, adding the Fed isn’t likely to provide a cushion to the economy with rate cuts in the near to medium term. “The act taken today by the White House puts the Fed in much more difficult position, given the pressure on both sides of its mandate.”
By Thursday morning, some economists had lowered their projections for the number of interest-rate cuts they see in 2025. Morgan Stanley said they now expect no cuts this year, down from one.
Investors, however, tilted the other way. Fed funds futures, possibly reflecting higher recession fears, implied the outlook for rate reductions had increased. That market now points to three to four cuts this year.
The Fed left borrowing costs unchanged last month. Policymakers have emphasized the labor market is healthy and the economy is solid overall. But the uncertainty caused by Trump’s rapidly-evolving trade policies had stoked fears of higher inflation and tanked sentiment among consumers and businesses even before Wednesday’s announcement.
A closely watched survey from the University of Michigan showed consumers’ outlook for inflation over the next 5 to 10 years rose in March to its highest level in more than three decades. The outlook for personal finances declined to a record low.
Many business leaders are in wait-and-see mode, putting investment plans on hold until there is more clarity in the outlook for tariff policy and tax legislation. Forecasters have also downgraded their growth outlook for the year, according to the latest Bloomberg survey of economists.
A substantial escalation in tariff tensions with back-and-forth retaliatory levies against major trading partners could slow economic activity in the U.S. and globally, economists said.
“If you get that escalation scenario, then you’re just talking about fundamentally less productive economies around the world,” Seth Carpenter, chief global economist at Morgan Stanley, said Wednesday morning on Bloomberg TV ahead of the tariff announcement. “It’s not a zero-sum game. It could actually be a net loss for the whole global order.”