"New Federal Reserve News Agency": The Federal Reserve's forecasts point to "stagflation," and expectations for "recent interest rate cuts" are changing, while investor reactions are sluggish

Despite Powell's insistence that the impact of tariffs will be temporary and will not change the Federal Reserve's policy stance, analysis indicates that, based on the Fed's economic forecasts, Trump has made a significant shift in the economy from a "soft landing" to "stagflation," and the interest rate outlook has changed, while investors have reacted sluggishly.

On March 19, Wall Street Journal reporter Nick Timiraos published an article pointing out that the Fed's latest forecast shows that the U.S. economy is facing the risk of "stagflation," where economic growth slows while inflation rises.

Fed officials originally expected to gradually cut interest rates by 2025 to achieve a "soft landing," but the latest forecasts indicate that tariffs may lead to rising prices while suppressing investment, confidence, and economic growth.

The article quoted Fed Chairman Powell's remarks at a press conference: "We are now facing inflation from external sources, but prior to that, the underlying inflation situation was basically 2.5% inflation, 2% growth, and a 4% unemployment rate."

The article argues that the combination of stagnant economic growth and rising prices—i.e., "stagflation"—may make it difficult for the Fed to preemptively prevent an economic slowdown through interest rate cuts this year. While some officials still expect two rate cuts this year, the expectations for "near-term rate cuts" are changing, which seems not to be fully recognized by investors.

Renowned economist El-Erian stated before the Fed's decision was announced that the market needs to familiarize itself with a new concept, namely "bad rate cuts." The challenge for the Fed is to delay rate cuts while convincing the market that there is still a significant probability of future rate cuts, not because of declining inflation (good news), but because of economic deterioration (bad news). The Fed hopes to avoid triggering inflation expectations while retaining flexibility for future policy adjustments.

Controversy Over "Temporariness"

The article also reviewed two cases in which the Fed responded to economic shocks in the past few years to provide insights for current decision-making.

In 2019, faced with the threat of tariffs from the Trump administration, the Fed believed that the impact on business confidence and investment could outweigh the inflationary pressures from rising prices of imported goods. At that time, inflation was generally below the Fed's 2% target, and they believed that any price increases related to tariffs would be a one-time event. Ultimately, they chose to cut interest rates.

In 2021, as the U.S. economy recovered from the pandemic, inflation began to rise. However, Fed officials believed that the cost pressures from supply shocks would quickly ease—this was the controversial "temporary" inflation. Later, they had to make a 180-degree turn and raise interest rates at the fastest pace in 40 years to combat inflation.

On Wednesday, Powell acknowledged that under "tariff inflation," the "temporary" diagnosis might be appropriate. Powell also stated that the current situation is "different," and "we have not fully restored true price stability, and we must keep this in mind." The standard monetary policy theory suggests that if a negative supply shock (such as a surge in oil prices) is expected to lead to a one-time increase in the prices of affected goods, policymakers should "ignore" this shock—in other words, not change the planned interest rate path that was set before the shock occurred.

However, this is not easy in practice. Former Federal Reserve Vice Chairman Donald Kohn stated, "The economy is much more complex, with many small feedback loops. You have to figure out how much is temporary and how much might persist due to these second-round effects, and there is no clear way to do that."

The article points out that Federal Reserve officials are closely monitoring expectations for future inflation, as they believe these expectations have self-fulfilling characteristics. If businesses and consumers become more accepting of higher inflation, it may become more difficult for the Federal Reserve to keep inflation within its target range.

Former Boston Fed President Eric Rosengren stated, "I think this is the fundamental reason why this will not be viewed as a one-time temporary shock. Inflation has been above its target for four consecutive years, and we are once again facing a situation of price level changes."