The FedDoes Nothing about the Wait and See Economy
At the May 8th Federal Reserve FOMC meeting interest rates were leftat 4.25%-4.50%. This was the third consecutive time the US central bank hasheld rates steady. Fed policy is now in very much of a wait and seegame. Hence, Wall Street is waiting to pivot on the potential impact oftariff-related inflation and prospects for slower economic growth (increasinglylikely taking the form of a recession). Fed chairman Jerome Powell did all hecould to make the press conference boring, almost urging markets to "movealong, there is nothing to see." That may work for now, but the June FOMCmeeting could be much more interesting given the current treasury curveindicates the market assigns a much lower chance of a rate cut in June than inJuly.
What to take from the meeting?
1. The Fed, like much of the US business sector,has adopted a wait and see approach to the economy, due to the uncertaintygenerated by the Trump administration's four-pronged strategy: restructure theAmerican economy; focus on trade, immigration, deregulation; and tax reduction.The economy contracted by 0.3% in Q1, down from Q4 2024's 2.4%, much ofit due to the administration's erratic trade policy, which has erodedconfidence in markets, injected considerable uncertainty in corporate businessplans (cooling expenditure and hiring plans), and causing consumers to be morecautious in spending. Indeed, the University of Michigan Index of ConsumerSentiment registered its fourth consecutive decline in April, plunging 8% fromMarch. According to the University of Michigan, consumer expectations havefallen a "precipitous" 32% since January, "the steepestthree-month percentage decline since the 1990 recession."
2. Fed officials noted that uncertainty aboutthe economic outlook has "increased further". They alsowere careful to say that the economy continued to expand at a "solidpace", downplaying Q1's marginal GDP contraction. The contraction waspartially due to a $140.5 billion trade deficit in March, with goods importsclimbing 5.4% to an all-time high of $346.8 billion. Although imports fromChina were at their lowest levels in five years, imports from most countrieswere the highest on record. As tariffs fall into place, imports are expected tofall as are US exports. This factors into the Fed's cautious approach to ratespolicy. Moreover, big questions exist over whether the expected price hikes andshortages caused by the tariffs will be temporary or will have a longer shelflife. Chances of recession are up, probably over 50%, but the depth ofthat downturn has yet to be determined.
3. The big challenge for the Fed in the monthsahead is to balance inflation and employment. At thispoint both are under control, though inflation stands at 2.4%, above the statedFed 2.0% target. If there is an increase in inflation (which we expect) the Fedwill remain neutral on rates, not wishing to repeat the high inflation of theBiden years. However, this policy approach could see more friction withemployment goals if the economy also slumps and the pace of unemploymentincreases (remember that job losses are also coming in government downsizingand there could be more from the corporate sector as companies adjust to theadministration's anti-trade agenda). We expect this friction betweeninflation control and employment to grow in the next several months as theTrump administration's policies advance.
4. Although the Trump White House clearly wantslower interest rates, the Fed is better positioned now to deal with whatevereconomic direction the economy takes. Unlike in 2021, there isroom for interest rate cuts. At the same time, maintaining rates can helpbuffer inflationary pressures. The Fed has also reduced its balance sheet froma high of around $9 trillion in 2022 to $6.7 trillion as of April 16, 2025.Although not optimal, the Fed could roll over maturing Treasury bonds or buymore. And there are other tools at the Fed’s disposal.
It is easy to forget that the Fed is data driven in how it makesits decisions. Markets want decisions now and the White House wants action lastweek. This makes the Fed a slower and more deliberate actor in the formulationof implementation of its policies. It is also important to remember that theFed is not just Chairman Powell, but made up of a board of 12 voting members.The last FOMC vote was supported by all members. The next FOMC meeting isscheduled for June 17-18; by then there should be more data on the impact oftariffs, whether there will be any trade deals (hopefully the deal with the UKadvances quickly), and more data on inflation and employment. That said, itmight be until July that the Fed moves on rates. Until then we are all left inwait-and-see mode, while markets are likely to remain volatile. Cash and goldare likely to keep their attraction in this environment.
Scott B. MacDonald, Ph.D.
Chief Economist
Smith's Research & Gradings
