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Executive Summary:

  • The Federal Reserve (Fed) is facing a tricky balancing act: controlling inflation while keeping the economy strong.

  • Tariff policies from the Trump administration add uncertainty, leaving businesses, investors, and consumers in the dark about what comes next.

  • Tariffs could drive higher inflation, while economic uncertainty may suppress consumer spending, potentially slowing job growth.

  • Markets want clarity and are pricing in further rate cuts, but policymakers may remain hesitant, waiting to see how tariffs and economic conditions evolve as inflation still hovers around 3%.

 

Uncertainty

 
“I don’t know anyone who has a lot of confidence in their forecast.”
Federal Reserve Chair Jerome Powell, March 19, 2025

Federal Reserve Chair Jerome Powell has, on multiple occasions, compared economic uncertainty to walking through a dark room filled with furniture, explaining, “You just slow down”[1]. The most recent was in December 2024, after the Fed embarked on an easing cycle, reducing the target interest rate by a total of 100 basis points (1.00%) over three months. At that point, the economy and the labor market were in great shape, and inflation was trending lower but remained above the Fed’s target of 2.00%. Uncertainties were beginning to emerge, especially around the incoming administration’s economic policies, and the market was beginning to question how that may impact the Fed’s decision making. The Fed was content to maintain rates at what they consider to be a restrictive level to keep inflation at bay while waiting to see what would happen next.


We’ll explore the Fed’s dual mandate in more detail later in this piece, but we think this context is essential as we consider what the Fed may do next. Uncertainty has only increased since Powell last used the “dark room” comparison (we recently highlighted the Uncertainty Index at record highs) and sentiment has declined rapidly.



One of the key drivers of the recent market volatility has been the Trump administration’s initial focus on trade policies. Markets are struggling to digest the steady stream of tariff threats, on again/off again implementation, pauses, exemptions, and retaliations from key trading partners. The lack of clarity makes it difficult for investors, business owners, and consumers to determine the path ahead. Likewise, the Federal Reserve will not be able to predict with certainty what the impact will be in the short term, making them hesitant to make any dramatic policy changes. They believe they are well positioned now to wait for greater clarity.


The economic outcome will depend heavily on the duration and extent of the tariffs, which is currently unclear. The Trump administration emphasizes the long-term goals of tariffs, including protecting American industry, creating a fair-trade environment, and improving border security, which they believe will benefit both the country and financial markets in the long run. In addition, sentiment could improve rapidly if the President turns his attention to previously announced economic policies aimed at boosting growth and supporting markets, including deregulation, lower taxes, infrastructure investment, and energy independence. The Fed will try to determine the net effect of all these policies when determining the next policy move.


Will the Fed step in to support markets?

Market expectations regarding Fed activity swing wildly, and keep in mind that bond markets don’t always react as one would expect to Federal Reserve actions. As shown in the blue line in the chart below, the Fed cut rates by 100 basis points at the end of 2024, but long-term rates have increased since then, which is very unusual compared to prior cutting cycles. It is a stark reminder that the Fed can only control short-term target rates while the rest of the curve is driven by factors such as future growth and inflation expectations. (See our post, What Is Driving The Bond Market?, for a refresher on how different forces can impact rates)


 

Expectations for Fed rate cuts have increased recently as equity markets turned lower amidst volatility and growth concerns. Market participants are currently pricing in two or three additional rate cuts by the end of the year.[2] However, inflation remains elevated above the Fed’s 2% target – a significant difference in the backdrop now compared to President Trump’s first term, when inflation was running below 2% (not to mention the magnitude of tariffs were much less extreme then). While the precise impact is difficult to quantify, the Fed believes that tariffs have at least delayed further progress on getting inflation back down to its target.


When describing the potential economic impact of tariffs, former Federal Reserve President Bill Dudley put it bluntly, “Markets seem to think that if the president won’t stop the damage, the Federal Reserve will. I think they’re too complacent.”[3]


The Fed’s Dual Mandate:

Remember that the Fed’s dual mandate consists of two key objectives: price stability and maximum employment.[4] The challenge? These two goals sometimes conflict. For example, aggressive rate hikes to combat inflation can slow down job growth, while keeping rates too low for too long may overheat the economy. Both sides of the Fed’s dual mandate are currently under tension, as shown in the sentiment survey below, where expectations for both unemployment and inflation are on the rise.  

 


Stable Prices (Inflation Control)

  • On one hand, tariffs are a tax paid by businesses importing goods, and trade partners typically retaliate with tariffs of their own – this may raise prices for consumers and disrupt supply chains (inflationary)

  • On the other hand, elevated prices and extreme uncertainty may suppress consumer spending, which could cause economic activity to slow or pause long enough to create a recession (job losses, potentially deflation)


The Fed is hyper-aware that higher prices disproportionately impact those who can least afford it. Given that the surge in inflation, which reached 9% in 2022, is fresh on the Fed’s mind, and inflation has yet to reach the Fed’s 2% target (it has been moving sideways around 3% for the last several months[5]), we believe the Fed will be hesitant to reduce the target rate further, even as tariffs and growth concerns loom.


Maximum Employment

The labor market has been a pillar of strength supporting consumers and the economy, and the current unemployment rate remains relatively low at 4.1%[6]. The push/pull in the labor market going forward will be between federal job cuts, pressuring the unemployment rate higher, and a dramatic reduction in immigration. As shown in the chart below, immigration played a significant role in population growth over the last several years.[7] This also increased the size of the labor force, filling job gaps and aiding labor shortages that emerged during the COVID-19 pandemic.



While a reduction in immigration is unlikely to directly offset federal job cuts given the difference in job types and skills, it will likely lead to a tighter labor market. When the size of the labor force declines, the unemployment rate can fall misleadingly even if job growth is weak. Even federal workforce reduction and a slowdown in growth may not generate as much slack in the labor market and downward pressure on wages as anticipated, which are some of the key indicators used by the Fed to identify weakness in the labor market.


What is the Fed planning to do now?

While the Fed always painstakingly emphasizes data dependence and a meeting-by-meeting decision-making progress, it releases a quarterly “dot plot” showing each Fed participant’s individual projections. The most recent was at the March 19th meeting, which is interesting timing given that the effects of tariff policies aren’t yet fully reflected in the hard economic data. However, sentiment and survey data have deteriorated, and inflation expectations have increased. These are critical inputs for the Fed; inflation expectations are thought to be self-fulfilling, so the Fed uses them as a guide to prevent inflation from spiraling out of control.


At the latest Fed meeting, Chair Powell and the committee left the target interest rate unchanged, as expected, and signaled a measured pace of easing for the remainder of the year may be appropriate, although they are closely watching the economy for signs of deterioration. Key changes to the “dot plot” were as follows:

  • Reduced the median growth forecast for 2025 by 0.4% to 1.7%

  • Increased the median core inflation forecast for 2025 by 0.3% to 2.8%

  • The median expectation of two additional rate cuts this year was unchanged, but there was more dispersion in the dots, including eight officials who penciled in one or fewer rate cuts for the remainder of the year. The wider range of opinions from members of the committee reflects broader uncertainty.



In his press conference following the Fed announcement, Fed Chair Powell mainly followed the script of prior meetings, emphasizing that the economy is strong, the labor market is in balance, and inflation has moved toward the 2% goal but remains somewhat elevated. However, this meeting had an increased focus on uncertainty, which Powell called “unusually high”. He also mentioned tariffs many times and said they contributed at least in part to the increased inflation forecast, although it is difficult to measure the impact precisely. They believe further progress on inflation may be delayed, at least in the short term, because of the tariffs and related trade policies.


Overall, Chair Powell appears comfortable with the current policy stance, explaining that the Fed doesn’t need to rush to adjust policy while awaiting more clarity. He projects a sense of calm and avoids reacting to short-term market volatility. His commentary about the changes (or lack thereof) in the “dot plot” projections also indicated that the committee sees potentially weaker growth and higher inflation balancing each other out, and they would lean towards holding steady in the face of remarkable uncertainty.[8] As former Fed President Dudley pointed out in the quote referenced above, markets may be too complacent in assuming the Fed will come to the rescue without a compelling reason to do so, such as material and persistent economic weakness, rather than stock market volatility.


Bottom Line

Uncertainty remains a dominant theme in financial markets and monetary policy, as highlighted by Federal Reserve Chair Jerome Powell's recent quip, “I don’t know anyone who has a lot of confidence in their forecast.”[9]


The Fed faces a challenging balancing act between controlling inflation and maintaining employment. Tariffs and trade wars may drive inflation higher by increasing costs, yet uncertainty and weaker consumer sentiment could slow economic growth in the short term. While markets expect further rate cuts, the Fed remains cautious, recognizing that inflation has yet to stabilize at the target rate and higher deficit spending remains a risk for 2025 and beyond. Employment remains strong but faces pressures from federal job cuts and immigration policy shifts.


For portfolios, high-quality fixed-income securities continue to offer relatively attractive yields of 4-5% for low-risk assets like US Treasuries, certificates of deposit, and investment-grade corporate bonds. Bond ladders, or a portfolio of bonds with staggered maturities, can be an excellent option for investors prioritizing stability, predictable income, and capital preservation, reducing interest rate risk and enhancing flexibility. This will continue to be a useful strategy regardless of how the Fed proceeds in the near term and independent of perfect market timing.


Encouragingly, high-quality bond funds like the US Aggregate Bond ETF (AGG) have proven to be a defensive diversifier amidst the equity volatility so far this year, returning approximately 2% through mid-March, while the S&P 500 large-cap equity index was down nearly 4% in the same period.[10] Please feel free to reach out to us to discuss the fixed income needs in your investment portfolio.

 

Sources

[2] Bloomberg World Interest Rate Probability as of March 19, 2025

[3] “These Tariffs Will Be Worse Than Markets Think: Bill Dudley” Bloomberg Opinion March 12, 2025

[5] Bureau of Labor Statistics

[6] Bureau of Labor Statistics

[7] Chart Source: US Census Bureau, FHN Financial

[9] Chair Powell’s Press Conference March 19, 2025

[10] Bloomberg as of March 14, 2025

Important Disclosures

The views expressed in this piece are the author’s and may not represent the opinion of Investment Research Partners. The views are as of the date listed on the material and are subject to change based on changes in fundamental economic or market-related data. Forecasts regarding the market, economy, and individual securities are subject to a wide range of possible outcomes. Past performance may not be representative of future results, and all investments are subject to loss. This piece is not intended as individualized investment advice. Before participating in any investment program or making any investment, readers are encouraged to consult with their own professional advisers, including investment advisers and tax professionals.



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