With uncertainty comes growing economic risk for the Fed to weigh

WASHINGTON: Since US President Donald Trump took office in January, he has imposed biting new tariffs, with more coming, begun a disruptive cull of federal jobs and spending, risked a political fracture with Europe, and acknowledged that an economy that was by most measures fine when he took over now faces some bumps, or worse.

Business and consumer sentiment have dropped, some measures of manufacturing have weakened, and the stock prices that contributed to record household wealth just as Trump was about to return to Washington have declined sharply, a possible precursor to slower spending among wealthier households that has propped up overall consumption.

Employment growth has largely persisted, and inflation has continued to moderate, according to the most recent data, but tariffs imposed by the US and retaliatory actions from trading partners raise the chance that could reverse.

It’s a lot to take in and next week Federal Reserve officials -- the most important US economic decisionmakers outside of the new administration -- gather in Washington to try to make sense of how the landscape has shifted since they last met in January.

Fed Chair Jerome Powell has said it was “not for us to criticise...or praise” the administration’s decisions, but he will have to manage the fallout, and if the landscape in January was uncertain, the risks that were largely speculative at that point have become more tangible.

A recent Reuters poll found near unanimity among economists that near-term recession risks have risen, while some top economic forecasters say slowing growth may be accompanied by still rising prices.

The two together could force Powell and his colleagues into difficult choices between supporting the economy and jobs with interest rate cuts, or keeping rates higher to ensure inflation and inflation expectations remain controlled.

‘DETOX’

The Fed is expected to keep borrowing costs steady at its March 18-19 meeting, but new economic projections will show how the group of 19 policymakers see Trump’s first months playing out in terms of unemployment, inflation and growth, and the monetary policy needed in response. Investors expect the Fed to cut rates by three-quarters of a percentage point over the next nine months, compared with the half-percentage point policymakers expected as of December.

In his last remarks ahead of the meeting, Powell gave “guidance on sticky inflation, inflation falling faster than expected, and an unexpected weakening of the labour market,” SGH Macro Advisors Chief Economist Tim Duy wrote after Powell’s appearance in New York last week, scenarios in which the Fed would either maintain the current high level of interest rates longer than expected, or approve further cuts. “He does not provide guidance on the combination of higher inflation and weaker employment. Of course, that’s the most interesting policy question now.”

The possibility of conflict between the Fed’s 2.0 per cent inflation target and maximum employment goals has crept into policymaker speeches as the breadth of Trump’s tariff plans raised concerns they might deliver both an extensive price shock and, just as important for the Fed, a shock to public expectations.

Coupled with other actions that could slow growth, such as the firing of federal workers and the cancellation of federal contracts, Trump’s first days have unleashed a contradictory set of forces that leave the Fed to assess whether the things that could increase prices or the ones that could slow growth and employment come to dominate.

Treasury Secretary Scott Bessent called it all a period of “detox” to shift the economy away from public spending. Commerce Secretary Howard Lutnick said even a recession would be “worth it” to put Trump’s policies in place.

WORRYING SIGNS

The blow to markets and sentiment has been significant.

The S&P 500 is down over 10 per cent from last month’s record, well below where it was when Trump’s election set off a bout of optimism among businesses that he would keep a strong economy on track.

Rates on short-term Treasury securities have risen above long-term yields, with investors accepting less return on a 10-year note than for a three-month bill, an ‘inversion’ of the yield curve that sometimes signals a loss of confidence in the economy over the short term.

While Fed officials have been reluctant to put much weight on it, the gap between the 10-year and 3-month Treasuries was flagged in earlier Fed research as the most useful spread to monitor.

Surveys have also shown sentiment dropping among small businesses, while a recent release from software firm Intuit, based on data from businesses using their payroll software, showed small firms shedding jobs in January.

The headline data, typically published in one-month intervals with a lag, hasn’t shown as much recent movement, with much of it dating to days near the start of Trump’s still less than two-month old term.

Firms added 151,000 jobs in February, with the unemployment rate still at a relatively low 4.1 per cent, though the survey that produced those estimates was too early to catch the likely building impact of layoffs of government workers and at firms or institutions that have seen their federal contracts threatened or cancelled.

GOLDMAN GROWTH DOWNGRADE

Inflation continued to moderate, with Fed officials still on the whole confident it would continue to ease toward their 2.0 per cent target.

But consumption also dipped unexpectedly in January, and consumer-facing companies, from airlines to retail giants like Target, are warning of wary consumers and a flat sales outlook.

Meanwhile indexes that try to track uncertainty, which can weigh on spending decisions by consumers and businesses, spiked to levels not seen since the Covid-19 pandemic.

In a recent forecast update, Goldman Sachs economist Jan Hatzius knocked his 2025 growth outlook for the US from 2.4 per cent to 1.7 per cent, and noted the downgrade had nothing to do with recent economic data that has remained at least “decent” if not supportive of growth.

“The reason for the downgrade is that our trade policy assumptions have become considerably more adverse,” given the size of Trump’s tariffs and his apparent intent to extend them globally. In addition, the administration now appeared to be “managing expectations towards tariff-induced near-term economic weakness”.