Trump's tariff policy puts the Federal Reserve in a dilemma: fight inflation or maintain growth?

With President Trump's tough stance on trade policy, the Federal Reserve is facing a complex situation: should it take measures to curb inflation or prioritize supporting economic growth?

The Trump administration has attempted to use tariffs as tools of foreign and economic policy, but this has created a delicate balance for the Federal Reserve's policymaking. According to the Zhitong Finance APP, many economists believe that tariffs could raise prices while weakening GDP growth, with the key issue being the extent of the impact and whether the Federal Reserve needs to make corresponding policy adjustments.

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, pointed out that tariffs may bring price shocks but could also be offset by a stronger dollar. However, in the long run, tariffs are generally detrimental to economic growth. Jones stated, "This combination puts the Federal Reserve in a real dilemma."

Currently, trade frictions between the Trump administration and China, Canada, and Mexico are ongoing. Although the tariff plans for Canada and Mexico have been temporarily suspended and negotiations are still in progress, the trade dispute with China continues to escalate, causing market sentiment to become tense.

In the economics community, tariffs are typically seen as a factor that raises prices, but historical data has not provided clear evidence. For example, the Smoot-Hawley Tariff Act of 1930 not only failed to cause inflation but also exacerbated the deflationary pressures of the Great Depression.

Trump also implemented tariff policies during his first presidential term. At that time, U.S. inflation levels were low, and the Federal Reserve was raising interest rates to find a "neutral" rate level. However, tariffs triggered a manufacturing recession, although this impact did not spread throughout the entire economic system.

But the current situation is different. The latest tariff policies proposed by Trump are no longer targeted at specific goods but may cover a broader range of product categories, which could change the Federal Reserve's monetary policy calculations. Charles Schwab predicts that if these tariffs are fully implemented, GDP growth could decrease by 1.2%, while the core inflation rate could rise by 0.7%, potentially exceeding 3% in the coming months.

Jones believes that these broad tariff measures "will have a greater impact on prices and a larger shock to economic growth." She predicts that the Federal Reserve may delay interest rate cuts due to the uncertainty surrounding tariffs and maintain a wait-and-see approach in the face of rising inflation, only adjusting policy when economic growth begins to be significantly affected. "But the Federal Reserve is indeed in a difficult position right now because this is a double-edged sword."

Currently, the market generally expects the Federal Reserve to keep interest rates unchanged in the coming months and to observe the actual impact of tariff policies rather than taking action based solely on policy statements. Additionally, the Federal Reserve will assess the effects of a cumulative 1 percentage point rate cut over the last four months of 2024.

If trade frictions ease or the impact of tariffs on inflation is less than expected, the Federal Reserve may refocus on the employment target within its dual mandate rather than concentrating solely on inflation issues.

"At present, the Federal Reserve's policy stance is relatively firm, and the repeated issues surrounding tariffs will not directly change this stance, especially since we do not even know how these policies will ultimately be implemented," said Eric Winograd, Head of Developed Markets Research at AllianceBernstein He expects that the specific impact of tariffs will gradually become apparent in the coming months, and the Federal Reserve's policy adjustments will not respond immediately.

Winograd believes that although tariffs may lead to a short-term increase in the prices of some goods, they will not bring the long-term inflationary pressures that the Federal Reserve typically focuses on. This view is also consistent with recent statements from Federal Reserve officials. They believe that monetary policy decisions will only be truly affected if tariffs lead to a full-blown trade war or have a more profound impact on supply and demand.

Boston Federal Reserve President Susan Collins stated in an interview, "There is a great deal of uncertainty about how policies will evolve, and we cannot accurately predict their impact without a clear understanding of the final policies." She emphasized that the Federal Reserve's stance is to "remain patient and act cautiously, with no urgent need to further adjust policies at this time."

The market still expects the Federal Reserve to cut interest rates for the first time at the June meeting, followed by a possible 25 basis point cut in December. The Federal Reserve maintained the federal funds rate in the range of 4.25%-4.5% last week.

Winograd stated that the Federal Reserve may still cut rates two to three times this year, but it will not start immediately; rather, it will wait for the impact of tariff policies to become more evident. He said, "Considering the overall resilience of the U.S. economy to trade frictions, I do not believe that the tariff issue will significantly change the Federal Reserve's policy direction. The market's response mechanism to the Federal Reserve has been overly mechanized—believing that once inflation rises, the Federal Reserve must respond, but that is not the case."