Fed maintains rates but signals risk of stagflation

REAL ECONOMY BLOG | May 07, 2025

Authored by RSM US LLP

The Federal Open Market Committee held its policy rate steady in a range between 4.25% and 4.5% on Wednesday. But the Fed updated its policy statement in which it highlighted the risk of stagflation because of the significant shift in U.S. trade policy.

The key sentence in the statement was, “The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”

By changing its statement to reflect emerging risks to the economy, the Fed is signaling that it will lean toward the side of its dual mandate—which includes maximum sustainable employment and price stability—that is furthest from its goal.

As of today, that is inflation. It is reasonable to conclude that the Federal Reserve will not be cutting rates in the near term.

In addition, given Powell’s repeated reminder that price stability is a pre-condition of maximum sustainable employment, the Fed is not coming to rescue of trade policy in the near term even as the economy slows.

In his news conference, Powell went out of his way to explain that the Fed needs time to evaluate the impact of tariffs on the economy, inflation and unemployment.

While the traditional Fed playbook would be to look through a one-time increase in the price level caused by tariffs, retaliation by U.S. trade partners and consumers’ rising inflation expectations command the attention of central bankers.

They are not willing to risk an intensification of stagflation, which best describes the current condition of the economy.

Financial markets continue to price in a 25 basis-point rate cut in July, which we think is far too early. Both the statement and Powell’s remarks were not supportive of risk, and we expect financial markets to respond accordingly heading into the summer.

Our provisional forecast, of a 25 basis-point cut at the September meeting, is predicated on economic data more clearly showing the impact of trade taxes on the economy.

At this point, we think the risk to our forecast is skewed toward no rate cuts this year because of the looming price shock.

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This article was written by Joseph Brusuelas and originally appeared on 2025-05-07. Reprinted with permission from RSM US LLP.
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