The Federal Reserve’s latest economic projections signal a significant shift in expectations for 2025, reflecting the impact of President Donald Trump’s trade policies.
Initially, policymakers anticipated a gradual reduction in interest rates to guide the economy toward a “soft landing.” However, the introduction of widespread tariffs has altered that outlook, raising concerns about inflation, slowing investment, and potential economic stagnation.
Fed Chair Jerome Powell acknowledged on Wednesday that tariffs have introduced an external source of inflation. Previously, the central bank projected stable growth of around 2%, inflation at 2.5%, and unemployment at 4%. The new forecast, however, suggests weaker economic expansion, higher inflation, and a potential increase in joblessness.
The combination of slowing growth and rising prices—often referred to as stagflation—could complicate the Fed’s ability to cut interest rates as planned. While Powell stopped short of calling the situation a major crisis, economists warn that prolonged inflationary pressures could make rate cuts less likely.
“You’re looking at a whiff of stagflation,” said Jay Bryson, chief economist at Wells Fargo. “It’s not the extreme scenario of the 1970s, but the risks are rising.”
Despite concerns about inflation, financial markets responded positively to the Fed’s decision to keep interest rates steady. Stocks rose on Wednesday, buoyed by the expectation that the central bank might still move forward with two rate cuts later this year.
President Trump, however, urged the Fed to lower borrowing costs more aggressively. In a social media post, he argued that rate cuts would help offset the impact of tariffs on the economy.
“The Fed would be MUCH better off CUTTING RATES as US Tariffs start to transition (ease!) their way into the economy,” he wrote.
The Fed’s current dilemma mirrors previous periods of economic uncertainty. In 2019, when Trump introduced tariffs on China, the Fed ultimately responded with rate cuts, believing that trade-related price increases would be temporary. Conversely, in 2021, officials underestimated the persistence of inflation following the COVID-19 pandemic, leading to aggressive rate hikes.
Now, Powell and other policymakers must determine whether tariff-driven price increases will be short-lived or contribute to a longer-term inflation problem.
“We haven’t had real price stability fully re-established yet, and we have to keep that in mind,” Powell said.
Economists caution that tariffs could trigger broader economic adjustments, making it difficult for the Fed to treat the resulting inflation as a temporary shock. If businesses pass on higher costs to consumers and supply chains shift, price pressures could persist beyond 2025.
Former Boston Fed President Eric Rosengren warned that inflation expectations could become more entrenched.
“Inflation has been above its target for four years, and now we are going to see another round of price-level changes,” he said.
While Powell suggested that tariff inflation could be a “transitory” phenomenon, the Fed remains cautious. Policymakers are monitoring both inflation trends and economic growth indicators before deciding on future rate adjustments.
For now, the Fed is taking a wait-and-see approach. Interest rates remain at 4.3%, and officials are assessing whether economic conditions will allow for rate cuts later in the year. However, the uncertainty surrounding tariffs and their broader impact on investment and consumer spending means the central bank’s policy path remains unpredictable.
“The Fed is well-positioned to wait for further clarity,” Powell concluded. “We’re not in a hurry to make changes until we see more evidence of where the economy is heading.”
The Wall Street Journal and BBC contributed to this report.
