Tariffs put Fed in tough spot, caught between growth and inflation fears

New York – An aggressive suite of

tariffs announced on April 2

by US President Donald Trump will significantly complicate the Federal Reserve’s job as it struggles to quash inflation and avoid an economic downturn, likely keeping officials in a wait-and-see mode.

“They’re basically our worst-case scenario,” said Ms Diane Swonk, chief economist at KPMG, who added that the tariffs raised the likelihood of an economic slowdown in the US.

But Ms Swonk and other economists said Fed officials will likely hold off on lowering rates to cushion the economy while they assess the potential impact of the tariffs on inflation.

The levies, which are harsher than many analysts were anticipating, are expected to raise prices on trillions of dollars in goods imported each year if left in place. A full-blown trade war, with escalating retaliatory tariffs between the US and other countries, could disrupt supply chains, reignite inflation and worsen a souring economic outlook.

Mr Trump said on April 2 the US would apply a minimum 10 per cent levy on all imports to the US, but tariffs on many countries will far exceed that. China’s cumulative effective rate is estimated to exceed 50 per cent. The European Union will have a 20 per cent levy and Vietnam is seeing a 46 per cent tariff.

Bloomberg Economics estimated the new levies could lift the average effective tariff rate in the US to around 22 per cent, from 2.3 per cent in 2024. Mr Omair Sharif, president of Inflation Insights, calculated a level of 25 per cent to 30 per cent.

For Fed officials still working to rein in the price gains that spiked during the Covid-19 pandemic, the inflationary fallout from the President’s actions may limit policymakers’ ability to step in and bolster the economy. 

Fed chairman Jerome Powell is scheduled to speak at a conference on April 4.

“It puts the Fed between a rock and a hard place,” said Mr Jay Bryson, chief economist for Wells Fargo & Co. “On the one hand, if growth slows and the unemployment rate comes up, they want to be more accommodative, they want to be cutting rates. On the other hand, if inflation goes up from here, they kind of want to be raising rates. So it really puts them in a tough spot.”

Mr Joseph Brusuelas, chief economist at RSM US LLP, agreed the new regime was far tougher than many analysts expected and will raise the probability of a US recession. “I expect inflation into 3 per cent to 4 per cent range by the end of the year,” he said, adding that the Fed is not likely to provide a cushion to the economy with rate cuts in the near to medium term.

“The act taken today by the White House puts the Fed in a much more difficult position, given the pressure on both sides of its mandate.”

The Fed left borrowing costs unchanged in March. Policymakers have emphasised the labour market is healthy and the economy is solid overall. But the uncertainty caused by Mr Trump’s rapidly evolving trade policies had stoked fears of higher inflation and tanked sentiment among consumers and businesses even before the April 2 tariff announcement.

A closely watched survey from the University of Michigan showed consumers’ outlook for inflation over the next five to 10 years rose in March to its highest level in more than three decades. The outlook for personal finances declined to a record low.

Many business leaders are in wait-and-see mode, putting investment plans on hold until there is more clarity in the outlook for tariff policy and tax legislation. Forecasters have also downgraded their growth outlook for the year, according to the latest Bloomberg survey of economists.

A substantial escalation in tariff tensions with back-and-forth retaliatory levies against major trading partners could slow economic activity in the US and globally, economists said.

“If you get that escalation scenario, then you’re just talking about fundamentally less productive economies around the world,” said Mr Seth Carpenter, chief global economist at Morgan Stanley. “It’s not a zero-sum game. It could actually be a net loss for the whole global order.” BLOOMBERG