\n<\/p>\n
Flags outside the Fairmont Royal York in downtown Toronto, Feb. 3, 2025.\u00a0<\/p>\n
Andrew Francis Wallace | Toronto Star | Getty Images<\/p>\n<\/div>\n<\/div>\n<\/div>\n
A complicated scenario is emerging surrounding the tariff drama that could put the Federal Reserve in an uncomfortable Catch-22, unsure whether to use its policy levers to tame inflation or boost growth.<\/p>\n
With many bridges to cross yet in President Donald Trump<\/a>\u2018s efforts to use the levies as a tool both of foreign and economic policy, the central bank will have a delicate balance to strike.<\/p>\n Many economists expect the tariffs both to raise prices and shave the pace of gross domestic product, with the main question being a matter of degree on the extent of any need for Fed policy adjustments.<\/p>\n \u201cMaybe you get that price shock and maybe it\u2019s offset by the dollar going up vs. the currencies of the countries subject to tariffs. But just really the long-term effects tend to be negative for growth,\u201d said Kathy Jones, chief fixed income strategist at Charles Schwab. \u201cYou put that combination together and it puts the Fed in a real bind.\u201d<\/p>\n There are a lot of moving parts happening in the dispute Trump is having with China, Canada and Mexico<\/a>, the three leading U.S. trade partners. As things stand now, threatened duties against Canada and Mexico have been postponed as the president negotiates with leaders of those governments. But the situation with China has quickly escalated into a tit-for-tat conflict that has markets on edge.<\/p>\n That tariffs cause higher prices is practically an article of faith for economists, though the historical record provides less certainty. The Smoot-Hawley tariffs in 1930, for instance, actually proved to be deflationary as they helped worsen the Great Depression.<\/p>\n When Trump launched tariffs in his first term, inflation was low and the Fed was raising rates as it sought a \u201cneutral\u201d level. A manufacturing recession ensued<\/a> in 2019, though one that did not spread to the broader economy.<\/p>\n This time around, the targeted tariffs that Trump had previously used have been replaced by the threat of blanket duties<\/a> that could change the monetary policy calculus. Schwab projects that the tariffs at full strength could cut 1.2% off GDP growth while adding 0.7% to core inflation, pushing the latter measure above 3% in the months ahead.<\/p>\n<\/div>\n Broader tariffs \u201chave both more price impact and more growth impact down the road,\u201d Jones said. \u201cSo I could see [the Fed] staying on hold longer, with the threat of tariffs hanging over the market and maybe seeing these price increases and then having to pivot to easing later in the year, or next year, or [whenever] that growth impact shows up.\u201d<\/p>\n \u201cBut they\u2019re definitely in a tough spot right now, because it\u2019s a two-sided coin,\u201d she added.<\/p>\n Indeed, markets largely expect the Fed to hold tight<\/a> for at least the next several months as policymakers observe the reality against the rhetoric on tariffs, along with looking for the impact from a full percentage point of interest rate cuts in the final four months of 2024.<\/p>\n If any of the parties blink on tariffs, or if they are less inflationary than thought, the Fed can go back to focusing on the employment side of its dual mandate and pivot away from inflation concerns.<\/p>\n \u201cThey\u2019re very comfortably on hold right now, and the back and forth on tariffs won\u2019t impact that, especially since we don\u2019t even know what they\u2019re going to look like,\u201d said Eric Winograd, director of developed market research at AllianceBernstein. \u201cYou\u2019re talking multiple months before this will meaningfully impact their thinking.\u201d<\/p>\n Winograd is among those who think that while tariffs could result in one-off boosts to some prices, they will not generate the kind of underlying inflation that Fed officials look at when making policy.<\/p>\n That matches some of the recent statements from Fed officials, who say that tariffs are likely only to affect their decision-making if they generate a full-blown trade war or somehow contribute to more fundamental supply or demand drivers.<\/p>\n \u201cThere\u2019s a lot of uncertainty about how policies unfold, and without knowing what actual policy will be implemented, it\u2019s just really not possible to be too precise about what the likely impacts are going to be,\u201d Boston Fed President Susan Collins told CNBC in an interview on Monday. From a policy perspective, Collins said her current stance is to \u201cbe patient, careful, and there\u2019s no urgency for making additional adjustments.\u201d<\/p>\n Market pricing<\/a> is still pointing to a likely Fed rate cut at the June meeting, then possibly one more quarter percentage point reduction in December. The Fed last week opted to hold the federal funds rate steady<\/a> in a range between 4.25%-4.5%.<\/p>\n Winograd said he sees a scenario where the Fed can cut two or three times this year, though not starting until later as the tariff situation plays out.<\/p>\n \u201cGiven how insulated the U.S. economy generally is from trade frictions, I don\u2019t think it moves the Fed needle very much,\u201d Winograd said. \u201cThe market is presuming too mechanical of a reaction function from the Fed where if they see inflation go up, they have to respond to it, which simply isn\u2019t true.\u201d<\/p>\n<\/div>\n<\/div>\n\nA different history<\/h3>\n
\u2018A lot of uncertainty\u2019<\/h3>\n
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