Fed Faces Tough Choices As Trade Tensions Stir Economic Uncertainty

The Federal Reserve is grappling with an economic landscape it hasn’t faced in decades, as President Donald Trump’s aggressive trade policies raise the risk of both higher inflation and rising unemployment. With Fed officials convening for their latest two-day policy meeting, they face a delicate balancing act that could shape the direction of the U.S. economy.

Trump’s unpredictable trade war is testing the Fed’s ability to simultaneously manage inflation and protect jobs. If the Fed cuts interest rates to cushion the economy from the impact of tariffs, it risks accelerating inflation. On the other hand, raising rates to contain potential price increases could slow growth and raise unemployment.

Most experts believe the Fed will hold its benchmark interest rate steady at 4.25% to 4.5%, maintaining the pause in rate hikes that began in January.

“The Fed is caught in this wait-and-see approach, and the next round of data should swing them one way or the other,” said Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth. “Once we get to early June, the economic data should give much greater insight on the impact of tariffs.”

Trump has been openly critical of the Fed’s stance, pressuring the central bank to lower rates and accusing Chair Jerome Powell of being slow to respond to economic threats.

The Threat of Stagflation

Economists are increasingly concerned that Trump’s tariffs could trigger a rare and troubling mix of stagnant growth and rising inflation — known as stagflation — a phenomenon that last posed serious challenges in the 1970s and 1980s.

Fed Chair Powell recently acknowledged the possibility that the central bank’s dual goals — maximum employment and stable prices — could come into conflict. Whether any inflationary spikes caused by tariffs are temporary will be key to determining the Fed’s response.

“I’m willing to look through whatever tariff price effects there are,” said Fed Governor Christopher Waller. “I’m not going to overreact to any increase in inflation that I think is attributable to the tariffs.” However, he noted that a sharp rise in unemployment would compel the Fed to take action.

So far, the labor market remains resilient. Employers added 177,000 jobs in April, and the unemployment rate held steady at 4.2%. But economists warn that ongoing tariff uncertainty could soon disrupt hiring.

There are already signs of strain. U.S. GDP contracted at an annualized rate of 0.3% early this year — the first quarterly decline since 2022 — as businesses and consumers scrambled to adjust to shifting trade rules.

Still, Fed leaders have said they need more data before making major policy moves.

“This is a good moment for us to take our time and make sure we’re moving in the right direction,” said Cleveland Fed President Beth Hammack. She emphasized that the Fed remains ready to act swiftly if conditions warrant — as it did in 2022, when inflation surged to 40-year highs and the central bank responded with rapid rate hikes.

Tensions Rise Between Trump and the Fed

Beyond policy concerns, the Fed also faces political pressure as Trump continues to undermine the central bank’s independence. He has repeatedly criticized Powell and floated the idea of removing him from office.

At a recent White House event, Trump said, “If I want him out, he’ll be out of there real fast, believe me.” However, after warnings from top advisers about the potential market fallout, Trump appeared to soften his stance. In a recent NBC interview, he said he doesn’t plan to fire Powell, but added that he’ll “get to change him very quickly anyway” when Powell’s term ends in May 2026.

Powell has maintained that the president lacks legal authority to remove a Fed official without cause. He is expected to address questions from the media during a press conference scheduled for 2:30 p.m. ET on Wednesday.

The Fed’s next steps — and its ability to maintain independence — could have lasting implications for the economy and financial markets alike.