The biggest question facing the Federal Reserve as it gathers again this week is how to grapple with a tariff-related “tug-of-war” between sticky inflation and a slowing economy — as well as a president who wants looser monetary policy.
How that dilemma gets resolved could mean two very different courses for interest rates in the coming months.
President Trump has made his views known in recent weeks: He wants rates lowered ahead of any slowing of the economy possibly triggered by his trade policies.
And he is not happy with the caution of Fed Chair Jerome Powell, who has said the central bank will “wait for greater clarity” while weighing both sides of its mandate for stable prices and full employment.
US Federal Reserve Chair Jerome Powell speaks at the Economic Club of Chicago on April 16. (Kamil Krzaczynski/AFP via Getty Images) ·KAMIL KRZACZYNSKI via Getty Images
There is a “strong likelihood,” Powell said last month, that the economy will be moving away from both of the Fed’s goals for the “balance of the year, or at least not making much progress.”
New reports on the economy, jobs, and inflation released last week reinforced the Fed’s conundrum as it looks for patterns in the data.
A GDP report showed the US economy contracted for the first time in three years to begin 2025 due largely to a rush by importers to beat the start of President Trump’s tariffs.
Read more: The latest news and updates on Trump’s tariffs
But an April jobs report released Friday also showed the labor market remained resilient even in the weeks after Trump’s “Liberation Day” announcements shook markets.
An inflation gauge favored by the Fed showed that price growth slowed in March to an annualized 2.6%, but it was still a hotter-than-expected 3.5% for the quarter. And both marks are above the Fed’s target of 2%.
Some economists expect inflation to kick higher and the economy to fall further in the months ahead.
The challenge for the Fed, Wilmington Trust bond portfolio manager Wilmer Stith said, is that it has to ferret out “the tug-of-war between how much inflation is over the 2% target versus a deteriorating job market.”
Luke Tilley, chief economist for Wilmington Trust, isn’t expecting much change in the Fed’s stance at this week’s meeting. He does expect Powell to reiterate the tension between lower growth and higher inflation.
“They will hold where they are at this meeting, citing all of the uncertainty and that, if you look through the GDP data that still looks pretty strong and domestic demand was strong,” he said.
Tilley said underlying demand was actually inflated during the first quarter by businesses stocking up on inventory ahead of the president’s tariffs.
He expects the economy to slip into a mild, short recession in the second quarter, which he expects will lead the Fed to cut rates.
“I expect that by the end of the year they will be cutting rates and more so than they think right now — and more so that they’d ever be willing to say right now,” Tilley said.
Tilley sees a rate cut at every meeting for the rest of the year starting in June, amounting to 125 basis points of reductions by year-end.
But he doesn’t think the Fed will cut until there is an actual drop in economic growth.
That could lead to even more tension with the occupant of the White House. Trump in recent weeks has repeatedly made clear that he wants the Fed to cut rates and has accused it and Powell of being late.
Read more: How much control does the president have over the Fed and interest rates?
“There can be a SLOWING of the economy unless Mr. Too Late, a major loser, lowers interest rates, NOW,” the president posted on his social media website, Truth Social, on April 21, saying that “‘Preemptive Cuts’ in Interest Rates are being called for by many.”
The White House even studied firing Powell before Trump made it clear he had “no intention” of firing the chair, whose term expires in May 2026.
President Trump delivers a commencement address at the University of Alabama in Tuscaloosa on May 1. (Reuters/Leah Millis) ·REUTERS / Reuters
Powell and some other Fed officials have stressed that the Fed must keep inflation expectations well anchored and that the central bank needs to ensure that one-time price increases from tariffs do not turn into ongoing inflation.
That seems to imply officials would err on the side of holding rates steady to keep inflation and inflation expectations in check.
Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments
But not everyone inside the Fed may feel that way, indicating that the debate in the coming months could get heated.
Fed governor Chris Waller, for example, said last month that he expects that the tariffs’ impact on inflation and jobs will be simultaneous and that he would err toward the side of needing to cut rates if the unemployment rate went up.
Waller said if the unemployment rate started ticking up by a tenth each month, it “wouldn’t be a big problem,” but if it starts going up two or three tenths per month, it would be indicative of layoffs taking off.
Esther George, former president of the Kansas City Federal Reserve, is among those who believe the real risk for the Fed is whether inflation from tariffs proves to be longer-lasting.
“Some people call it hawkish,” George said. “I don’t think it’s so hawkish as it is just practical to say in a more stagflationary environment, the one thing I can affect is inflation, and the anchoring of expectations is going to be critical here, because you might be able to take a rise in unemployment to a certain level.”
George says she could see the Fed justifying keeping rates higher than they might otherwise even if there’s an uptick in unemployment because the central bank needs to keep inflation expectations, which have been ratcheting higher due to tariffs, in check.
“It’s not that they’re going to be late, it’s that they are carefully evaluating the contours of this data to help them judge what the stance of policy is,” she said.
Tilley is among those who argue inflation won’t be long-lasting if the US consumer and economy do, in fact, weaken. He downplayed any return of a so-called stagflation situation that roiled America in the 1970s, with inflation rising and the economy weakening at the same time.
“We are not in a stagflation late-1970s scenario here in any way, shape, or form,” Tilley said. “Like it’s not even close, which means you can have the weakening in the economy and inflation would follow it down. It wouldn’t keep going up like it did then.”
Read More: What is stagflation, and how does it impact you?
George said the Fed needs to be careful about keeping inflation expectations in check because “the odds [of recession] are growing every day,” as a result of tariffs and uncertainty.
“I think the dynamic of the impact of shifting supply chains and alliances at a minimum is going to cause a weaker economy, not a stronger one, certainly in the short term,” George said.
And whether it’s a recession or just slow growth, George said it may not matter because slower growth is just as damaging as a recession, hitting employment and productivity.
George expects the Fed will be faced with adjusting rates in the second half of the year if the economy is weak. If the unemployment rate starts ticking up past 4.5%, that will get the Fed’s attention.
If the jobless rate rises, she said, “I think that will be their signal they need to cut.”
Click here for in-depth analysis of the latest stock market news and events moving stock prices
Read the latest financial and business news from Yahoo Finance
