FOMC holds rates as they wait for more clarity

As expected, the Federal Open Market Committee decided to keep its benchmark policy rate unchanged at 4.25%–4.50% at its May meeting.

The Fed continues to see the U.S. economy as resilient and is waiting to see if the weakness in soft data translates into weakness in hard data. With risks to their dual mandate rising, the Fed prefers to wait for additional clarity before adjusting policy, especially as the outlook remains extremely uncertain.

The current assessment

While survey data continued to deteriorate as sentiment data has soured, suggesting businesses and households have postponed decisions amid trade policy uncertainty, the negative impacts of the tariff shock have not shown up in actual economic data.

The Fed continues to see solid current labor market conditions, inflation moving sideways at a fairly low level, and longer-term inflation expectations well-anchored. They also continue to characterize broad economic activity as solid, downplaying the weak Q1 GDP print as a function of swings in net exports. This likely stemmed from front-loaded imports ahead of tariff deadlines, which provides little useful information.

The Fed did caution that risks of a stagflationary environment—higher unemployment and higher inflation—have risen, though Fed Chair Jerome Powell emphasized the need for more data to determine the appropriate stance of monetary policy. Uncertainty is extremely elevated, as it’s yet to be seen whether the current level of tariffs will be sustained, and to what extent they may evolve in the coming months as potential trade deals emerge.

Powell remains confident that the Fed is well positioned to wait for additional clarity on how trade policy will impact the economy as the costs of postponing monetary action are low. As a result, there is no immediate urgency to reduce policy rates.

Asked about political jawboning from President Donald Trump, Powell stressed that it does not affect the Fed’s job at all. Moreover, he also dismissed questions on whether he would step down from the Fed after his position as Fed Chair ends in May 2026.

Policy outlook

While the brunt of the tariff shock has yet to meaningfully impact hard economic data just yet, it may be only a matter of time, especially if existing tariffs are sustained at their currently elevated levels. With both inflation and unemployment potentially increasing as a result, the Fed has been plunged into an almost impossible situation.

The Fed is also beholden to fiscal policy—itself incredibly uncertain— and this too will dictate both the timing and magnitude of their future monetary policy decisions.

Complicating matters more, recent headlines suggesting President Trump is taking a hardline approach to China trade negotiations further reinforces the uncomfortable position for the Fed.

In this situation, what else can the Fed do but sit on its hands? Rate cuts will be required but, increasingly, it seems that they will need to wait until late Q3 before the window of opportunity opens.

Principal Asset Management