Federal Reserve’s Stance on Interest Rates Hinges on Sustained Inflation Improvement Amid Tariff Uncertainties
A recent statement from a Federal Reserve official indicates a cautiously optimistic outlook on inflation, fueled by a better-than-expected inflation report and a temporary trade truce. However, the official emphasized the need for significantly more evidence of sustained low inflation before considering further interest rate cuts.
Austan Goolsbee, president of the Federal Reserve Bank of Chicago and a voting member of the Fed’s rate-setting committee, expressed his views on the current economic landscape. He acknowledged the positive aspects of the recent inflation data, describing it as "a benign report" and "comforting." The April inflation reading, coupled with a 90-day pause on the highest tariffs on Chinese imports, has seemingly brightened the inflation outlook, potentially paving the way for the Fed to resume its rate cuts.
Despite this cautious optimism, Goolsbee cautioned against premature action. He highlighted the potential risks associated with upcoming economic developments, particularly the effects of tariffs. "When you have things that you know are coming down the pipe, we’ve just got to be more wary," he stated, underscoring the need for a measured approach.
Goolsbee’s perspective holds particular significance due to his reputation as one of the more "dovish" members of the Fed’s rate-setting committee. Dovish policymakers tend to prioritize economic growth and employment, often favoring lower interest rates to stimulate the economy, even at the risk of slightly higher inflation. Conversely, "hawkish" policymakers prioritize controlling inflation, often favoring higher interest rates to curb price increases, even at the risk of slowing down economic growth. Goolsbee’s dovish leanings suggest that if he is hesitant to support further rate cuts, the bar for such action is likely to be quite high.
The Fed’s upcoming meeting on June 17-18 will be crucial in shaping the central bank’s monetary policy stance. Policymakers will carefully analyze the latest economic data, including inflation figures, employment numbers, and indicators of economic growth, to determine the appropriate course of action.
The latest inflation data revealed a slight decrease in annual inflation, dropping from 2.4% to 2.3%. This marks the lowest inflation rate in more than four years, moderately above the Fed’s 2% target. While this is a step in the right direction, Goolsbee emphasized that he did not observe any significant impact from tariffs in the recent inflation numbers. Tariffs, which gradually took effect from February to April, are expected to exert upward pressure on prices, potentially offsetting the recent decline in inflation.
Treasury Secretary Scott Bessent announced earlier in the week that the U.S. and China had reached an agreement to lower tariffs on each other’s goods. The U.S. agreed to reduce the 145% tariff on Chinese imports to 30%, while China committed to cutting its duties on U.S. shipments from 125% to 10%. This agreement, if sustained, is projected to have a significant impact on trade and inflation.
Economists estimate that the tariff reductions would lower the average U.S. tariff rate from approximately 24% to 13% and reduce projected U.S. inflation by year’s end from about 4% to 3.5%. While this would represent a substantial improvement, the projected inflation rate of 3.5% would still be well above the Fed’s 2% target.
Goolsbee acknowledged the potential impact of tariffs on the U.S. economy, noting that imports comprise about 11% of America’s economy. He suggested that if the impact of tariffs can be contained, its overall effect on the macroeconomy may not be substantial. However, he cautioned that if tariff rates exceed 10%, the impact could be significant.
Goolsbee used the metaphor of "dust in the air" to describe the uncertainty surrounding the effects of tariffs on inflation. Many economists believe that the effects of import fees will start to noticeably affect inflation readings in July and grow in subsequent months.
Goolsbee expressed hope that if the "dust" can be cleared, there is a path for interest rates to "keep coming down." However, he stressed the need for more data to confirm the downward trend in inflation.
The central bank cut its key short-term rate by a percentage point late last year as a pandemic-related inflation surge eased. However, the Fed has since paused its rate cuts, opting to wait and see how President Trump’s levies affect consumer prices.
Goolsbee’s remarks suggest that he is encouraged by the trade truce with China, a separate 90-day pause on double-digit tariffs on other nations, and soft inflation readings for both March and April. However, the uncertainty surrounding the effects of tariffs is preventing officials from confidently resuming rate decreases.
Goolsbee emphasized the need for "several more" inflation reports similar to the recent one before the Fed can envision a path for resuming its rate decreases. He stressed that "it’s got to be a lot of reports," highlighting the importance of sustained low inflation.
The Fed will also closely monitor the expiration of the 90-day pause for the tariffs imposed on dozens of nations on July 2. The U.S. is currently negotiating with many of those countries, raising the possibility of further trade agreements and tariff reductions.
Goolsbee refrained from providing a specific timeline for when Fed officials might resume their market-friendly rate cuts. Fed fund futures markets this week pushed their estimate of the first decrease from July to September, reflecting the uncertainty surrounding the Fed’s next move.
Fed officials face the challenge of balancing the effects of inflation with an economy and job market that is expected to weaken due to import taxes. Fed Chair Jerome Powell has acknowledged that tariffs have put the Fed’s mandates of stable prices and full employment "in tension."
Goolsbee acknowledged that a deteriorating job market in the coming months, before the effects of tariffs on inflation become clear, would present a "hard circumstance" for the Fed. In such a scenario, the Fed would have to carefully weigh the risks of raising interest rates to combat inflation against the risk of further weakening the economy and job market.
As the Fed contemplates a possible rate cut, it will likely assess whether the inflation rise from tariffs represents a one-time increase or a shock that could ripple through the economy due to an increase in consumers’ inflation expectations. If consumers expect inflation to rise, they may demand higher wages and prices, leading to a self-fulfilling prophecy of higher inflation.
