- The Federal Reserve held interest rates steady but signaled two possible cuts in 2025 amid inflation concerns and Trump’s escalating tariffs.
- Economic forecasts were downgraded, with inflation expected to rise to 2.7% and GDP growth slowing to 1.7% for the year.
- The Fed reduced its balance sheet runoff to $5 billion per month, aiming to ease financial market disruptions while navigating economic uncertainty.
The Federal Reserve opted to keep interest rates steady on Wednesday, signaling that two cuts are still on the table for 2025, even as the economy grapples with inflation spikes and sluggish growth triggered by President Donald Trump’s escalating trade war.
Despite Trump recently imposing steep tariffs on imports and teasing more aggressive levies in the coming weeks, the Fed appears to be playing the waiting game—watching how it all unfolds before making any drastic moves.
“We think the right thing to do here is wait for greater clarity in terms of what the economy is doing,” Fed Chair Jerome Powell stated during a press conference. “It’s really hard to know how this is going to work out.”
Inflation and Growth Forecasts Take a Hit
Alongside its rate decision, the Fed raised its 2025 inflation projection and cut its economic growth forecast, underscoring growing uncertainty in the financial landscape.
“Uncertainty around the economic outlook has increased,” the Fed noted in its statement after a two-day policy meeting. The central bank also removed its previous claim that “risks to achieving its employment and inflation goals are roughly in balance.” Powell acknowledged that tariffs are already adding fuel to inflation, warning that “further progress” in lowering prices “may be delayed.”
The benchmark short-term interest rate remains at 4.25% to 4.5%—unchanged for the second consecutive meeting—after officials trimmed it by a full percentage point from September to December, following a steep drop in inflation.
This means borrowing costs for credit cards, auto loans, and mortgages will stay lower than last year, though consumers shouldn’t expect another rate cut in the immediate future.
Trump’s Tariffs Complicate the Fed’s Next Move
While inflation has remained stubbornly high, the Fed hit pause on rate cuts earlier this year. Initially, this was expected to be a brief hold, but Trump’s tariffs arrived sooner and in a more aggressive form than anticipated, forcing policymakers to rethink their strategy.
Adding to the uncertainty, the administration has also initiated federal layoffs and mass deportations of undocumented immigrants—two moves that could significantly impact economic activity.
A Unique Economic Challenge: Stagflation
Typically, the Fed slashes interest rates to stimulate a weakening economy and raises them to curb inflation. But the current situation is more complicated.
Tariffs are acting as a double-edged sword: they are driving inflation higher as businesses pass the costs onto consumers while simultaneously slowing economic growth by sapping purchasing power. This rare economic dilemma—known as stagflation—leaves the Fed in a tough spot.
For now, the central bank is treading carefully, maintaining its December forecast of two rate cuts in 2025. Fed projections indicate a reduction of half a percentage point this year, bringing rates down to a range of 3.75% to 4%. But opinions are divided—nine officials anticipate two cuts, two expect three, and eight foresee just one or none at all.
“Broadly speaking, they balance each other out,” Powell remarked, acknowledging the risks posed by both inflation and a cooling economy. Despite recent weakness, he insisted that the economy is still “in a good place.”
Looking ahead, officials expect another two cuts in 2026, bringing rates down to approximately 3.4%, in line with previous projections.
Inflation, Economic Growth, and Unemployment Projections
- Inflation: The Fed now expects inflation to rise from 2.5% to 2.7% by the end of 2025, slightly above the 2.5% forecast in December. Core inflation (excluding food and energy) is projected to increase from 2.6% to 2.8%.
- Economic Growth: GDP growth expectations for 2025 have been revised down from 2.1% to 1.7%.
- Unemployment: The jobless rate is now expected to reach 4.4% by year-end, slightly higher than the December estimate of 4.3%.
Trump’s Tariff Plan: What’s Next?
Trump has already imposed a 25% tariff on imported steel and aluminum, a 20% duty on all Chinese imports, and a 25% levy on select goods from Canada and Mexico. Starting next month, further tariffs will take effect, including:
- 25% on remaining imports from Canada and Mexico
- 25% on autos, pharmaceuticals, and computer chips
- Reciprocal tariffs matching any levies imposed by foreign nations on U.S. exports
Economists are split on the long-term impact. Goldman Sachs predicts inflation will rise by 0.5% and growth will shrink by a similar margin. Some analysts foresee a more severe impact, estimating a 1% hit to both inflation and GDP. Meanwhile, JPMorgan Chase has raised the odds of a U.S. recession to 40%.
Economic Red Flags: A Slowdown in Spending and Investment
Inflation cooled rapidly last year but has since plateaued at 2.5%—still above the Fed’s 2% target. Core inflation briefly dropped to 2.6% in January but likely rebounded to 2.8% in February, according to Barclays.
Meanwhile, cracks are appearing in the economy:
- Retail sales plummeted in January and showed only a modest rebound in February.
- Consumer confidence has fallen sharply due to trade tensions and federal layoffs.
- The S&P 500 has tumbled 8% from its February high, erasing wealth for affluent Americans who drive much of consumer spending.
- Job creation remains steady (151,000 new jobs in the last month), but underemployment has reached a three-year high as businesses scale back hours.
- The Federal Reserve Bank of Atlanta predicts a 1.8% economic contraction in Q1 2025.
The Fed’s Balance Sheet Moves
In addition to interest rate policy, the Fed announced an adjustment to its balance sheet strategy. The central bank has been gradually shrinking its holdings of Treasury bonds and mortgage-backed securities—a move designed to reverse the pandemic-era stimulus and exert mild upward pressure on long-term interest rates.
However, with uncertainty over the debt ceiling looming, reducing the balance sheet too aggressively could disrupt financial markets. To mitigate risks, the Fed decided to slow the pace of its balance sheet reduction, lowering the monthly runoff of Treasury bonds from $25 billion to $5 billion.
The Road Ahead
While the Fed is keeping rates steady for now, all eyes are on future policy moves. If inflation remains sticky and economic data worsens, the central bank could be forced to rethink its approach—potentially slashing rates more aggressively than currently planned. The coming months will reveal whether the economy can withstand Trump’s tariffs or if deeper intervention will be required.
