Escalating trade tensions threaten to derail this nascent U.S. economic expansion. Federal Reserve Chair Jerome Powell has signaled that the central bank will adopt a cautious approach while awaiting further clarity on trade negotiations and their implications on the economy. This decision was swayed by recent economic indicators, which were very positive. Given the rocket ship rebound in growth during the second quarter after a mild first quarter contraction, the U.S. is a bit of an outlier.
After some data released earlier this year showed a slight pullback in U.S. expansion during Q1, fears began swirling among economists. That said, the economy bounced back hard in Q2, showing that the economy remains resilient even with international trade battles raging. This progress faces critical threats from escalating trade tensions and prospective tariffs. All of these things are sure to weigh heavily on U.S. growth numbers.
With June’s inflation hitting a four-month high of 2.7%, expectations grew that it would influence the Bank’s thinking on monetary policy. Analysts caution that even if the spike is short-lived, tariffs risk pushing inflationary pressures into the economy. Powell has long stressed the need to keep a watchful eye over brewing trade conditions. He’s adamant that the Federal Reserve will not act prematurely until it has a clearer picture of the bigger picture that tariffs will have an impact on.
At next week’s Fed press conference, assuming he’s not already fired, Jerome Powell should underscore this focus. He says he’ll hold off on implementing any policy changes until he gets more clarity on trade’s trajectory. This dovish, wait-and-see approach leaves the door open for a rate cut as early as September. It doesn’t ensure that those cuts will be realized. The Federal Reserve is actively trying to learn more about the effect tariffs have on inflation and economic growth. They hope to have this data available by their next meeting.
The Fed isn’t going to rush to cut rates, but it might if it observes malign risks to the economy manifesting in serious ways. What we cannot know is when or how fast these reductions will occur. If Powell’s confidence about the temporary nature of tariff-induced inflation turns out to be misplaced, that will apply downward pressure on the U.S. dollar. The Federal Reserve has repeatedly indicated that it will be patient to make decisions. They would like clean analytics on the economic changes and trends before making any irreversible moves.
The Federal Reserve is walking a very difficult tightrope. It should reflect the urgent need to recover now, as well as the long-term impact of trade and economic policies. How the mix of domestic economic indicators – inflation and employment levels – with external trade factors balance out will largely determine what path the central bank takes from here.