Tonight's Federal Reserve decision: On the surface, it remains steady, but behind the scenes, is it playing out a "strategic pivot"?

Tonight, the Federal Reserve will conclude its two-day monetary policy meeting and announce its latest policy interest rate. Although the market generally expects the Federal Reserve to remain on hold, a significant strategic shift is quietly underway beneath the surface.

According to the Federal Reserve's latest quarterly economic forecast, most officials expect one to two rate cuts this year. At first glance, this forecast is largely consistent with the outlook from December of last year (when most officials anticipated two rate cuts), but the underlying logic has changed significantly due to the potential threat of a trade war.

Analysts believe that the core issue of this Federal Reserve meeting is not whether to cut rates, but how to adjust its policy framework in the face of economic uncertainty. Although inflation data has declined, providing room for rate cuts, the potential threat of a trade war may force the Federal Reserve to adopt a more cautious stance.

The Shadow of Trade Wars and the Game of Inflation Expectations

The Federal Reserve could cut rates due to the good news of declining inflation, as was the case last year, or it could cut rates due to the bad news of an economic recession.

Currently, the likelihood of the first type of rate cut has decreased, as the possibility of Trump raising tariffs across the board is increasing. According to CCTV News, Trump previously reiterated during a joint session of Congress that he would begin imposing reciprocal tariffs on April 2. U.S. Treasury Secretary Mnuchin stated that by that day, each country would receive a "tariff number," representing the tariff levels they would face. Meanwhile, U.S. trading partners are on high alert, and a trade war is imminent.

Historically, the outbreak of a trade war is likely to lead to supply chain disruptions, driving up domestic inflation in the U.S. while suppressing economic growth. This "stagflation" risk puts the Federal Reserve in a dilemma. Wells Fargo Chief Economist Jay Bryson stated:

If inflation rises, the Federal Reserve needs to tighten policy; but if the unemployment rate rises, they need to loosen policy.

Federal Reserve officials are not unfamiliar with the potential impacts of trade wars. During the Trump 1.0 era, the Federal Reserve responded to the economic shocks brought about by trade wars through rate cuts. However, the current scale of the trade war may far exceed previous ones, and inflation levels have been above the Federal Reserve's target for four consecutive years. This poses greater challenges for the Federal Reserve in responding to trade wars.

Michael Reid, Senior U.S. Economist at RBC Capital Markets, stated: "Unlike in 2019, companies are now more focused on how to pass costs onto consumers." This ability to pass on costs may further drive up inflation, and the Federal Reserve must be wary of whether public expectations of inflation begin to form a self-fulfilling cycle.

The Federal Reserve's Rate Cuts Become More Cautious, No Action Expected in the Next Six Months?

Several Federal Reserve officials have indicated that they would be more cautious if there are signs that the public begins to expect inflation to persistently rise. Central bank officials are particularly focused on ensuring that consumer and business expectations of inflation remain low, as these expectations can become self-fulfillingPowell previously stated that the Federal Reserve does not need to rush to cut interest rates, trying to give itself some breathing room:

The cost of caution is very, very low. The economy is doing well. In fact, it doesn't require us to do anything, so we can wait, and we should wait.

Boston Fed President Eric Rosengren stated:

I expect the Federal Reserve may maintain a wait-and-see attitude over the next six months and will not take too much action.

He mentioned that he had expected tariffs to keep the Federal Reserve's interest rates unchanged for most of this year. However, he also expressed surprise that the magnitude of the tariffs that have already taken effect, as well as those that may be raised, exceeded his expectations.

The Federal Reserve's interest rate forecasts cannot easily capture the various potential outcomes that could lead to rate cuts or maintaining rates. Philadelphia Fed President Patrick Harker stated last month that when he has to submit a report in December, he is "undecided between cutting rates once or twice." In a media interview, he said:

I cannot support cutting rates 1.5 times.

Since then, making predictions has become increasingly difficult. "Uncertainty will be very high," Harker said, "No one in our industry can say for sure what will happen."