Fed may not cut in June & July amid Trump tariff uncertainty

·       Fed will not cut rates at Trump’s gunpoint; Fed expects 15.5% average weighted tariffs as base case and a stagflation-like scenario for the US economy

·       Fed sees Trumpflation as transitory, not persistent; thus, the Fed will refrain from any rate hikes

·       As US unemployment may surge to around 5% because of the Trumpcession, the Fed may start cutting rates from September’25;

·       By August, the Trump admin should be able to take a definitive tariff and tax cut (BBB) policy; the Fed is waiting for Trump's policy certainty

On June 1, 2025, Federal Reserve Governor Waller delivered a speech addressing current economic conditions and monetary policy. He discussed the U.S. economy's resilience, noting strong growth and low unemployment despite elevated interest rates. Waller highlighted that inflation remains above the Fed’s 2% target, though it has moderated. He emphasized a data-dependent approach to future policy decisions, suggesting that rates may need to remain restrictive to ensure inflation returns to target levels. Waller also acknowledged global economic uncertainties and their potential impact on U.S. policy, advocating for patience and flexibility in adjusting monetary policy to balance growth and price stability.

Relevant text of Fed Governor Waller: June 1, 2025

The Effects of Tariffs on the Three I’s: Inflation, Inflation Persistence, and Inflation Expectations

“The variability in tariff announcements this year, including the whipsawing of court rulings and doubling of metal tariffs last week, has created considerable uncertainty about where trade policy will settle. In mid-April, based on how things looked at the time, I proposed two scenarios to consider in framing an outlook and a preferred stance of monetary policy: a large tariff scenario and a smaller tariff scenario.

In both cases, I assumed that the tariff increases would lead to a one-time boost to prices that would temporarily raise inflation, after which inflation would return to its underlying rate. This temporary increase could play out with a prompt rise in inflation that could recede quickly, or it could occur more gradually with a more modest increase that would recede more slowly. As I will explain, crucial to this judgment is my assumption that longer-term inflation expectations remain anchored.

The large-tariff scenario I described assumed an average, trade-weighted tariff for goods imports of 25 percent, which is close to where things stood after the 90-day tariff suspensions announced on April 9, and my scenario assumed that this would remain in place for some time. In that case, I argued that inflation based on the personal consumption expenditures (PCE) price index could reach a peak of 5 percent on an annualized basis this year if businesses passed through all of the tariff costs to consumers. If firms absorbed some of the tariff increase, then inflation might peak around 4 percent. I also argued that an economic slowdown from these higher costs could push the unemployment rate up from 4.2 percent to 5 percent next year.

The smaller tariff scenario assumed a 10 percent average tariff on goods imports would remain in place, but that higher country and sector-specific tariffs would be negotiated down over time. In this case, inflation may rise to 3 percent on an annualized basis and then dissipate. Growth in output and employment would slow, with the unemployment rate rising but probably not as high as 5 percent.

Reported progress on trade negotiations since that speech leaves my base case somewhere in between these two scenarios. The temporary reduction in China tariffs has significantly decreased the trade-weighted average tariff since China supplied about 13 percent of U.S. goods imports in 2024. But that reduction is only temporary and is due to increase if a trade agreement is not reached by August 12.

Meanwhile, tariffs on other countries were temporarily lowered to 10 percent, but it is unclear where they will end up. Furthermore, the Administration continues to say that it plans additional tariffs on specific industries and sectors of the economy. Last week's court decisions declaring a large share of tariffs illegal introduce additional uncertainty, but there seem to be multiple options for maintaining tariffs, so I will stick with an estimated trade-weighted tariff right now of 15 percent on U.S. goods imports, which falls in between my large- and smaller-tariff scenarios. I see the risks of my large tariff scenario having gone down, but there is still considerable uncertainty about the ultimate levels, and thus about the impact on the economic outlook.

The context for this uncertainty about tariffs is that hard data on the fundamentals of the economy lately has been mostly positive and supportive of the Federal Open Market Committee's (FOMC) economic objectives. There is very little evidence of the effect of trade policy in this data on inflation or economic activity through April, but that may change in the coming weeks.

In comparison, there is evidence of tariff effects in the "soft data" based on surveys of consumers, businesses, and investors—indications of an expected slowdown in economic activity and an increase in prices. As of today, I see downside risks to economic activity and employment and upside risks to inflation in the second half of 2025, but how these risks evolve is strongly tied to how trade policy evolves.

A careful examination of the hard data on overall economic activity through April shows it has been, on balance, positive. I say this because, while real gross domestic product contracted slightly in the first quarter, private domestic final demand, a measure of spending by consumers and businesses, grew at a healthy annual rate of 2.5 percent in the quarter. Of course, economic policy uncertainty among businesses is very elevated, and this has affected measures of sentiment and confidence for consumers and businesses, which fell to historically low levels in April.

One index of this policy uncertainty compiled from newspaper stories, government reports, and the dispersion of the forecasts of private-sector economists rose in April to nearly twice the level seen during the pandemic and the Global Financial Crisis. However, consumer sentiment rebounded with the announcement that the China tariffs had been lowered temporarily. And households' spending should continue to be supported by income from the resilient labor market. In addition, my business contacts have told me that, because of tariff uncertainty, their investment plans are currently on hold but are not canceled. So we may see a slowdown in investment in the near term, but a jump back up later this year.

Wherever things end up on a continuum between my "large" and "smaller" scenarios, I do expect tariffs will increase the unemployment rate, which will, all else equal, probably linger. Higher tariffs will reduce spending, and businesses will respond, in part, by reducing production and payrolls.

We won't get the jobs report for May until this Friday, but the consensus expectation is that employers added 130,000 jobs and that the unemployment rate remained steady at 4.2 percent. We have seen a reduction in wage pressures over recent months, and the ratio of job vacancies to the number of unemployed people has moderated from as high as 2 a couple of years ago to close to 1 today, which was about where it was before the pandemic. With a balanced labor market, if aggregate demand slows noticeably, businesses will likely look to cut workers. But I believe job cuts would be modest if the smaller tariff scenario is realized. Most chief executives I have spoken to say that they can maintain their current operations with an effective tariff of 10 percent, looking for efficiencies here and there, and won't have to significantly reduce their workforces.”

Inflation

“Now let me turn to the outlook for inflation. Before the recent shift in U.S. trade policy, inflation had been making consistent, but uneven, progress over the past two years toward our 2 percent goal. While that progress seemed to stall at the beginning of 2025, it has resumed in the past two months. The same pattern of higher readings at the start of the year, followed by lower readings the next couple of months, also occurred in 2024, and I expect that research will eventually reveal some residual seasonal effect or other factor that has affected at least some prices early in the year.

Total PCE inflation for April rose 0.1 percent, and core PCE inflation without energy and food prices increased by the same amount. It was the second monthly reading at 0.1 percent or less, and it means that headline PCE inflation was up 2.1 percent over the 12 months through April and that core was up 2.5 percent. In the absence of the tariff increases, I was expecting inflation to continue coming down nicely to our 2 percent goal. But now I expect that the effect of higher tariffs will raise inflation in the coming months. The surge in imports to build up inventories ahead of the April 2 announcement makes the timing of price increases somewhat uncertain.

Thinking about the rest of 2025 and 2026, I expect the largest factor driving inflation will be tariffs. As I said earlier, whatever the size of the tariffs, I expect the effects on inflation to be temporary, and most apparent in the second half of 2025. This will be determined not only by the ultimate size of the increase but also by how exporters and importers respond, something that is highly uncertain. Will foreign exporters discount prices to try and preserve market share? Will domestic importers absorb some of the tariff increases to shore up demand and sales volumes? Will firms simply pass the entire tariff along to consumers?

Since about 10 percent of personal spending goes to imported goods, if the ultimate tariff levels are closer to my 10 percent smaller-tariff scenario and if that is fully passed through to consumers, then the tariff would push up prices 1 percent. But based on my conversations with business leaders, I suspect the tariff cost will not be fully passed through and, instead, the burden will be distributed something like 1/3, 1/3, and 1/3 among consumers, importers, and exporters. In this case, it would raise inflation by three-tenths of 1 percent for a short period. However, if the tariffs are higher than 10 percent, more of the increase is likely to be passed on to consumers, as businesses face limits in how much they can absorb and still find a way to remain profitable.

Inflation Persistence

“Let me now turn to the first of two issues about inflation that I want to cover in more detail. This is inflation persistence. The economics behind a tariff increase implies it should have a transitory effect on prices—tariffs raise prices once, but those prices don't keep going up. I know that hearing "transitory" will certainly remind many people of the consensus on the FOMC in 2021 that the pandemic-induced increase in inflation would be transitory. Inflation turned out to be much more persistent than we thought it would be. Am I playing with fire by taking this position again? It sure looks like it. So why do I believe a tariff-induced inflation spike will not be persistent this time?

Looking back at how inflation played out in 2021 and 2022, I believe three key factors increased the persistence of the initial burst of inflation in 2021. First, there was a negative labor supply shock that was more persistent than expected. I believed that once the economy reopened, all of this labor would return. However, many workers left the labor market because of illness, to care for children and family members, or took early retirement. They never returned.

And with every wave of COVID-19, the United States experienced additional waves of early retirements that inhibited the labor supply from returning to its pre-pandemic level. Also, with the service sector shut down, demand surged for goods as spending on travel and other services halted, and the negative labor supply shock led to a shortage of workers in goods production, delivery, and sales. Goods industries raised wages to attract workers, and then once the economy began to reopen, service-sector firms had to pay higher wages to get workers back. This persistent shortage of labor from several pandemic-related effects continued through 2021 and 2022 as job vacancies skyrocketed and firms had no choice but to pass along escalating wage increases in the form of higher prices.

I have heard the concern that some firms may raise prices opportunistically while blaming the tariff increase. There is always a risk that firms blame some purported cost spike for a price increase, but it doesn't happen often because of the risk of losing market share to competitors or squandering the allegiance of loyal customers. So while this may happen in isolated instances, I do not believe it will be a significant source of additional inflation above and beyond the tariff-induced increase.”

Inflation Expectations

“So, based on wage demands, spending patterns, and loan demand, I see no evidence of economic activity that conforms to the inflation views reflected in the University of Michigan household measures, which, like other polling about the economy in recent years, may reflect attitudes about other factors.

In conclusion, given my belief that any tariff-induced inflation will not be persistent and that inflation expectations are anchored, I support looking through any tariff effects on near-term inflation when setting the policy rate. Fortunately, the strong labor market and progress on inflation through April give me additional time to see how trade negotiations play out and how the economy evolves. Assuming that the effective tariff rate settles close to my lower tariff scenario, that underlying inflation continues to make progress toward our 2 percent goal, and that the labor market remains solid, I would be supporting "good news" rate cuts later this year.”

Highlights of comments by Fed’s Waller on June 2, 2025

·       Disagrees with central bank digital currencies

·       Stablecoins are a new way to introduce competition in the payment sector

·       Stablecoins are just a payment instrument

·       The Fed is actively exploring blockchain technology in a safe fashion

·       Doesn’t see how tariffs would create persistent inflation

·       Long-term yields rise amid foreign buyer anxiety

·       Doesn't view an issue selling government bonds

·       Long-term yields rise in part due to government fiscal concerns

·       Markets set long-term yields

·       Skeptical that a 10% tariff can boost inflation to 3%

·       Federal Reserve close to reaching inflation target

·       The policy should focus on the real side of the economy if inflation is near the goal

·       Tariffs will increase the jobless rate with a lasting impact

·       No comment on real-world issues with the expected path of inflation

·       Tariff inflation impact likely greatest in the second half of 2025

·       Some of the small-sized tariff regimes will not be passed along

·       Tariffs are likely to create a temporary price increase Fed can look through

·       We simply do not see how tariffs would lead to lasting inflation

·       Trade policy outlook still uncertain

·       A robust economy through April allows the Fed to observe the trade outcome

·       Tariffs to be the main driver of inflation year

·       Downside Risk to Economy, Job Market, Upside Risk to Inflation

·       Factors that led to the pandemic inflation spike are not currently present

·       Rate cuts remain possible later in 2025

·       The Effects of Tariffs on the Three I’s: Inflation, Inflation Persistence, and Inflation Expectations

·       Most Attentive to Market and Forecaster Views on Inflation

·       A strong economy through April gives the Fed time to observe how trade shakes out

·       Tariffs expected to result in a temporary price hike Fed can look through

·       Tariffs will increase joblessness and will probably persist

·       Downside risk to the economy, job market: upside risk to inflation

·       Considerable uncertainty persists surrounding the trade policy outlook

·       The rate cut view relies on easing inflation, tariffs on the lower end of the spectrum

·       Some small tariff regimes will not be passed along.

·       Possible rate cuts later this year

·       Tariffs main driver of inflation year-on-year

·       Tariff inflation impact is expected to be highest in the latter half of 2025

Overall, Waller indicated rate cuts in late 2025. Like Powell and other Fed officials, Waller also believes Trump’s tariff inflation is transitory rather than persistent, although it will inevitably cause a higher cost of living and higher unemployment. Waller sees Trump tariffs around 25% (~27.5%) as the worst case scenario if trade negotiations fail altogether including China; 15.5% average weighted tariffs as the base case scenario (10% basic universal + sectoral tariffs + exemptions) and 10% tariffs as best case scenario (no sectoral tariffs).

Waller also sees 5% highest PCE inflation in the worst case scenario (25.5-27.5% average weighted tariffs) and 3% in the base to best case scenario with equal 1/3rd distribution of the burden of tariffs among three primary stakeholders (importers, exporters, and consumers). Theoretically, the Fed should hike rates in inflation surges meaningfully above 3% to 4% or 5%, but this time Fed may not hike as Tariff inflation may be one-time, i.e., transitory rather than permanent. But Waller also reminded of the Fed’s failure to recognize post-COVID inflation as transitory and subsequent policy mistakes.

Waller explained the reason for persistent post-COVID inflation due to the unexpected shortage of the labor force amid various COVID-related issues. The supply-side issue of labor shortage caused higher wages and higher inflation. This time, Waller does not see such issues. But as there are still various Trump trade policy uncertainties, while the labor market is still strong, almost at maximum employment levels, and inflation is still somewhat above 2% targets, the Fed will be in wait & watch mode, at least till Q2CY25.

On June 3, 2025, Federal Reserve Governor Lisa D. Cook delivered a speech at the Council on Foreign Relations, focusing on the U.S. economic outlook and monetary policy. She noted that the U.S. central bank’s monetary policy is “well-positioned” to address various economic scenarios. Cook emphasized her commitment to maintaining long-term inflation expectations near the Fed’s 2% target while balancing employment and price stability goals. She highlighted risks from trade policies, particularly tariffs, which could increase inflation and slow economic activity, potentially leading to a stagflation-like environment. Cook advocated for a data-dependent approach, supporting steady interest rates amid uncertainties, and stressed the need to monitor how trade policies evolve to assess their impact on the Fed’s mandates.

The relevant text of Fed Governor Cook’s speech: June 03, 2025

Economic Outlook

“The U.S. economy is still on a firm footing, but uncertainty has notably increased since the beginning of the year. The latest data indicate that unemployment continues to be low, while inflation remains somewhat above the Federal Open Market Committee's (FOMC) 2 percent goal. However, there is evidence that changes to trade policy are starting to affect the economy. I do not express views on the Administration's policies. But I do study the economic implications, which appear to be increasing the likelihood of both higher inflation and labor–market cooling.

In this environment, monetary policy will need to carefully balance our dual-mandate goals of price stability and maximum employment. Former Chair Ben Bernanke said that, in times of uncertainty, policymakers must consider a range of possible scenarios about the state of the economy. The resulting policy decisions, he said, "may look quite different from those that would be optimal under certainty."

Let me start by looking at one part of our mandate. Inflation has declined from its pandemic highs but remains somewhat above target. The most recent data show that inflation was 2.1 percent for the 12 months ending in April and 2.5 percent when excluding food and energy costs. Price increases tied to changes in trade policy may make it difficult to achieve further progress in the near term. One-year inflation expectations have risen sharply this year. So far, most measures of longer-term inflation expectations have moved less significantly. I will continue to monitor this data carefully. The recent post-pandemic experience with high inflation could make firms more willing to raise prices and consumers more likely to expect high inflation to persist.

I will now turn to the other part of our mandate. The labor market has remained resilient, at least through early spring. The unemployment rate in April held steady at 4.2 percent, a historically low level. Payroll job gains averaged nearly 150,000 per month through four months this year, a moderation from last year. Trade policy changes could alter hiring plans shortly. Changes to global trading patterns could also hurt U.S. productivity. Though, as I noted in recent remarks, productivity gains associated with the introduction of artificial intelligence technology into the workplace could potentially, at least in part, counter that effect.

In terms of overall economic activity, U.S. GDP moved lower in the first quarter after solid growth last year. However, private domestic final purchases, which exclude net exports, inventory investment, and government spending, grew last quarter at a rate consistent with recent readings.

Looking ahead, I anticipate a slowdown in the expansion of economic activity from last year's pace. The ultimate level of tariffs remains unknown because policy changes are still developing. However, the effects are already noticeable. Manufacturing output declined in April. Orders for heavy trucks plunged. Firms reported a drop in capital expenditure plans for 2025. Measures of uncertainty have increased, on the net, this year, and household and business sentiment have declined, despite some recent improvements in both.”

Monetary Policy

“While the economy remains solid, the economic environment could become highly challenging for monetary policymakers. At our most recent policy meeting last month, I supported the FOMC's decision to leave our policy interest rate unchanged. The current stance of monetary policy is well-positioned to respond to a range of potential developments.

Trade policy changes and the response of financial markets, firms, and consumers suggest risks to both sides of our dual mandate. As I consider the appropriate path of monetary policy, I will carefully consider how to balance our dual mandate, and I will take into account the fact that price stability is essential for achieving long periods of strong labor market conditions.”

International Comparison

“Because the current paths for the U.S. and global economy are uncertain, I think it is helpful to study a recent period when that was also the case: the pandemic downturn and the inflation that followed. To launch our discussion, I will highlight two lessons from cross-country experiences that might apply today.

One lesson is that the inflation environment can change abruptly, especially in a world with global shocks. The pandemic revealed how large global shocks can generate severe supply and demand imbalances that, in turn, can cause surprisingly persistent inflationary pressures across economies. However, these factors were underappreciated during the post-pandemic economic recovery. As a result, forecasts around the world under-predicted inflation. Forecasters may be able to do better in the future by tracking new indicators regarding shortages, various sources of pressure on supply chains, and changes in the frequency of price adjustments, especially when price setters see an upside risk to inflation.

A second lesson is that credible inflation targeting is essential to keep longer-term inflation expectations anchored. Inflation targeting by central banks proved important during the post-pandemic economic recovery in achieving the monetary policy credibility that kept longer-term inflation expectations anchored. Recent research has provided support for this finding in both advanced and emerging economies. And that is precisely why I am committed to supporting a monetary policy that keeps longer-term inflation expectations anchored.”

Conclusion

“To summarize, I see the U.S. economy as still being in a solid position but heightened uncertainty poses risks to both price stability and unemployment. I will continue to monitor developments closely as I consider monetary policy decisions. When making decisions, I think it has been valuable to remain a student of economic history. Our recent past has provided some useful lessons for decision-making during periods of high uncertainty and elevated risks to our dual-mandate goals.”

Highlights of comments by Fed’s Governor Cook on June 3, 2025

·       The Fed's monetary policy is well-positioned for a range of scenarios

·       Trade policies create risks for Fed inflation and job mandates

·       Trade policy may make it harder to get inflation lower

·       Sees evidence that trade policy is now affecting the economy

·       The economy is in a solid position amid trade policy risks

·       Anticipates economic growth will slow this year

·       Firms may be more willing to raise prices now relative to the past

·       Monetary policy is well-positioned for a range of goals

·       Sees tariffs raising inflation and complicating rate policy

·       I see challenges to Fed mandates from tariffs, but we need to see how it plays out

·       Uncertainty acts like a tax on businesses

·       Fed's work on AI is very limited and careful

·       We can't prejudge what the FOMC will do with rates

·       I'm always watching the market functioning

·       Bond markets proved resilient in April amid stress

·       The Fed's goals for balance sheet drawdown haven't changed

Overall, Fed Governor Cook pointed out a high potential US stagflation-like economic scenario amid lingering Trump trade & tariff war uncertainty; the Fed would be now in wait & watch mode till at least August’2025, by when the Trump admin may take a confirmed tariff policy decision and implement if accordingly without the daily dose of flip-flops.

Conclusions

Fed may not cut in June-July 2025 amid lingering Trump tariff talk uncertainty, but may act in September’25 and December’25 depending upon Trump’s implemented tariffs and overall US economic situation. Fed may be wait & wait-and-watch stance till mid-September 2025, as by then, Trump’s tariff policies may take a potential clear shape of a 10% basic/universal rate with some sectoral tariffs ranging from 25% to 50%. Even if Trump makes a final decision of a 10% ‘smaller’ tariff, including that on China by early July (along with sectoral tariffs), the Fed needs time to evaluate the weighted average cost of tariffs on the economy and thus may act only from September 2025.

Trump may extend his reciprocal tariffs pause from July-August to December’25 to ensure no supply shock for the US economy. Trump will use the US adverse court ruling as an excuse for a face-saving exit from his tariff mess. Trump may continue his chaotic tariff policy to get a fair trade deal for the US. If Trump goes on with his higher reciprocal tariffs, it would cause a supply shock and a higher cost of living for ordinary Americans, most of whom live on a pay check to paycheck-to-paycheck basis. Further, such tariffs would cause a demand shock in the future and an all-out recession. This will also cause a loss of Vote Bank (ordinary Americans) and Note Bank (political funding by corporate America) for Trump and Republicans. Thus, court or no court, Trump is bound to blink and may take a less hawkish tariff position in the coming days.