Through all the twists and turns of President Trump’s tariffs, a widespread immigration crackdown and the scuffles surrounding the Republican tax and spending bill, the Federal Reserve has stayed steady in its stance that it can go slow in taking action on interest rates.
That message holds as officials gather on Tuesday for a two-day meeting, at which they are set to extend a pause in rate cuts that has been in place since January. It is also likely to endure throughout the summer, giving the Fed at least a couple more months before it must make a difficult decision about when and by how much to lower borrowing costs.
“As long as the labor market continues to look solid but inflation continues to mainly move sideways, it’s going to be a ‘wait-and-see’ situation,” said Jon Faust, a fellow at the Center for Financial Economics at Johns Hopkins University and a former senior adviser to Jerome H. Powell, the Fed chair.
When the central bank sets monetary policy, it has two goals in mind: keep inflation at 2 percent and ensure that the labor market is healthy. Currently, both aims are in sync.
Inflation has stayed remarkably stable in recent months. The latest Consumer Price Index report, released last week, showed price pressures remain well contained. Employers are hiring less than they once did and fewer workers are entering the labor force, but layoffs have yet to rise in a meaningful enough way to lift the unemployment rate.
The economy has all the makings of a soft landing, a rare feat in which the central bank tames inflation without pushing the economy into a recession. But such an outcome is not guaranteed. Mr. Trump’s policies have stoked fears that inflation will eventually re-accelerate, growth will slow and the labor market will weaken, forcing officials to make a tough decision about which of their goals to prioritize.
An escalating conflict between Israel and Iran that erupted last week threatens to make that trade-off more challenging. Oil prices have whipsawed, surging initially before receding on Monday. Higher energy costs, if sustained, could accelerate inflation and weigh on demand, a combination known as stagflation, providing yet another reason for the Fed to hold off on guidance about the path forward for interest rates at this week’s meeting.
“The oil price shock adds another stagflationary shock on top of the more unusual and larger tariff stagflationary shock,” said Lael Brainard, who served as vice chair at the Fed until she left to become the top economic adviser in the Biden administration in 2023. “It comes in the wake of a period of high inflation that is posing some risk to inflation expectations, so you can’t really think about these things in isolation,” she said.
That is likely to prompt the Federal Open Market Committee, the 12-person group that votes on policy decisions each meeting, to wait a bit longer “to observe how this plays out” before sending a clear signal about its next move on interest rates.
The path to lower borrowing costs, which Mr. Trump has been demanding with increasing urgency since returning to the White House, has never been straightforward because of his tariffs.
The most optimistic scenario is one in which the central bank felt confident enough about the trajectory of inflation to look past an expected jump in consumer prices. These “good news” rate cuts — as endorsed and described by Fed governor Christopher J. Waller — are based on the assumption that the labor market stays on solid footing. The opposite outcome is one in which the economy deteriorates to a point where officials would have to step in to limit the pain.
Absent the conflict in the Middle East, Richard Clarida, a former vice chair at the Fed, thought the odds of a such a cut later this year had risen compared with just a couple of months ago, when he had thought the labor market would have to crack for the central bank to cut rates. Most companies have held off on raising prices to account for higher costs from Mr. Trump’s tariffs, he noted. That could mean the eventual spike in inflation will be more contained overall if businesses continue to shield their customers. But it is too early to know for certain.
“The reality is that we have just not seen in our lifetimes U.S. tariffs at these levels,” said Mr. Clarida, who is a global economic adviser at PIMCO, an investment firm. “We’re really not going to know until we start to see it or not see it in the data.”
Despite the uncertainty, officials at the Fed will publish new economic projections on Wednesday as well as estimates for where policymakers expect to see interest rates through 2027 and over the longer run.
The last time such estimates were released were in March, most officials paired a higher inflation forecast with lower a forecast for economic growth, even as they stuck with previous predictions that they would be able to lower interest rates by half a percentage point this year. The federal funds rate stands at a range of 4.25 percent to 4.5 percent.
The updated projections are likely to calcify warnings made by officials in recent weeks that Mr. Trump’s policies could lead to an economic outcome that resembles stagflation, the combination of high inflation and sluggish growth. In May, the central bank’s staff penciled in a similar forecast, saying that a recession was “almost as likely” as its forecast for subdued growth. They also expected tariffs to boost inflation “markedly” before it falls back to the 2 percent target in 2027.
Ms. Brainard said that she still expects the Fed to lower interest rates this year. Two quarter-point cuts is a “reasonable assumption,” she said. Were it not for the Middle East conflict, she said, it would be appropriate for Mr. Powell to begin laying the groundwork at this week’s meeting for the central bank to begin cutting rates potentially as early as September.
Now, cuts are “probably a bit backloaded, because we just added this additional source of uncertainty,” Ms. Brainard said.
Jonathan Pingle, chief U.S. economist at the bank UBS, said he expects Fed officials to forecast only one quarter-point cut this year, reflecting the central bank’s priority in snuffing out inflation following many years of it running well above its target.
“With the labor market holding up OK in their minds, I think this meeting is about really looking like you’re going to fight inflation,” he said.
Mr. Pingle’s own forecast diverges from what he expects from the Fed this week, however. He believes officials will end up lowering interest rates three times this year, beginning in September. By then, he said, it would be obvious that the labor market was weakening and that the Fed’s tools are insufficient to combat inflation caused by a policy that constrains supply like tariffs.
It would not be the first time that officials jettisoned earlier forecasts. This time last year, policymakers went from forecasting one cut to lowering borrowing costs by half a percentage point three months later. It later reduced rates twice more.
“One thing that this Fed has shown is that they’re prepared to be agile when the picture clarifies,” said Mr. Faust. “That’s a good thing.”
Colby Smith covers the Federal Reserve and the U.S. economy for The Times.
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