Fed's Tough Choice: Combat Inflation or Prevent Economic Slowdown?

TLDR

Table of Contents

Federal Reserve set to maintain interest rates despite President Trump’s demands for immediate cuts
Trump-Powell showdown intensifies as Trump calls for “preemptive cuts” while Fed Chair waits for clearer economic signals
U.S. economy contracted in Q1 2025, the first decline in three years, partially due to importers rushing to beat Trump’s tariffs
Stock futures point to losses with Dow, S&P 500, and Nasdaq all falling; oil prices declining after OPEC decision
Economists predict potential “tug-of-war” between inflation (currently above Fed’s 2% target) and slowing economy

The Federal Reserve and Chair Jerome Powell are heading for a confrontation with President Donald Trump this week as the central bank prepares to hold interest rates steady despite Trump’s repeated calls for immediate cuts. The anticipated decision comes amid a complex economic landscape where first-quarter GDP contracted for the first time in three years, yet inflation remains above the Fed’s 2% target.

U.S. stock futures pointed to losses early Monday after the S&P 500 recorded its longest winning streak in more than 20 years last week. Dow Jones Industrial Average futures were down 221 points (0.5%), while S&P 500 and Nasdaq 100 futures both dropped 0.6%.

The stage is set for Wednesday when Powell will make remarks following the Fed’s two-day policy meeting. Market watchers widely expect the central bank to maintain current interest rates despite growing pressure from the White House.

🚨 The Week Ahead: Fed Rate Decision & Big Earnings
📊 Fed rate decision Wednesday – expected to hold at 4.25% – 4.5% despite Trump pressure
💼 Big earnings: Palantir, AMD, Ford, Disney & Uber
📈 S&P 500 $SPY rallying after tariff pressure eases
👀 Markets still pricing 3…
— Trader Edge (@Pro_Trader_Edge) May 4, 2025

The Trump-Powell Tension

President Trump has made his position crystal clear in recent weeks. He wants rates lowered ahead of any potential economic slowdown triggered by his trade policies.

“There can be a SLOWING of the economy unless Mr. Too Late, a major loser, lowers interest rates, NOW,” Trump posted on Truth Social on April 21. He added that “‘Preemptive Cuts’ in Interest Rates are being called for by many.”

The White House reportedly even studied the possibility of firing Powell before Trump clarified he had “no intention” of doing so. Powell’s term as Fed Chair runs until May 2026.

The Fed, however, remains cautious. Powell has stated the central bank will “wait for greater clarity” while weighing both sides of its mandate for stable prices and full employment.

“They will hold where they are at this meeting, citing all of the uncertainty,” said Luke Tilley, chief economist for Wilmington Trust. He believes the Fed will point to strong domestic demand despite the weaker headline GDP number.

Economic Crosscurrents

Recent economic data has created a puzzle for policymakers. A GDP report showed the U.S. economy contracted to begin 2025, largely due to importers rushing to beat the start of Trump’s tariffs.

Yet the April jobs report released Friday showed the labor market remained resilient even in the weeks after Trump’s “Liberation Day” trade announcements shook markets.

The inflation picture is equally mixed. The Fed’s preferred inflation gauge showed price growth slowed in March to an annualized 2.6%, but the quarterly figure came in hotter than expected at 3.5%. Both remain above the Fed’s 2% target.

Crude oil prices added to the uncertainty, dropping early Monday with West Texas Intermediate down 2.9% at $56.58 a barrel. This follows OPEC and its allies agreeing on Saturday to increase output in June by 411,000 barrels a day.

Wilmer Stith, Wilmington Trust bond portfolio manager, described the Fed’s challenge as a “tug-of-war between how much inflation is over the 2% target versus a deteriorating job market.”

Some economists expect inflation to increase and the economy to weaken in the months ahead. This potential stagflationary scenario complicates the Fed’s decision-making process.

However, Luke Tilley downplayed comparisons to the 1970s stagflation era. “We are not in a stagflation late-1970s scenario here in any way, shape, or form,” he said. “Like it’s not even close, which means you can have the weakening in the economy and inflation would follow it down.”

Esther George, former president of the Kansas City Federal Reserve, believes the real risk is whether inflation from tariffs becomes longer-lasting. She argues that keeping inflation expectations anchored is critical.

The debate inside the Fed may intensify in coming months. Fed governor Chris Waller stated last month that he would favor cutting rates if unemployment began rising consistently, especially if increases reached two or three tenths per month.

Deutsche Bank analyst Peter Sidorov wrote in a research note that their economists “continue to see the next rate cut coming in December and, while risks are tilted towards earlier easing, they see this as contingent on a weaker labour market.”

Tilley takes a more aggressive view, predicting rate cuts at every meeting for the rest of the year starting in June, totaling 125 basis points of reductions by year-end. However, he doesn’t think the Fed will cut until economic growth actually drops.

The 10-year Treasury yield stood at 4.312% early Monday, slightly down from the previous week, suggesting market expectations remain cautious about immediate policy changes.

Markets this week will also watch for developments on potential trade deals and tariffs. Trump authorized a 100% tariff on films produced overseas, calling it a response to tax incentives that have lured many Hollywood productions outside the U.S.

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