CSC: The Federal Reserve's interest rate meeting in June is expected to remain unchanged, with the biggest obstacles still coming from the uncertainties of tariffs and inflation

According to the Zhitong Finance APP, CSC published a research report stating that the Federal Reserve's interest rate meeting in June maintained its stance as expected, with the Summary of Economic Projections (SEP) raising inflation and unemployment rate forecasts while lowering growth expectations, and the dot plot indicating two rate cuts within the year. The Federal Reserve maintains a cautious position, although officials generally expect inflation to rise but ultimately fall back, and anticipate a higher unemployment rate, they are not in a hurry to ease. The biggest obstacle to the Federal Reserve's rate cuts still comes from the uncertainty of tariffs and inflation—how tariffs translate into inflation, as well as the timing and magnitude. Regarding the pace of rate cuts in the second half of the year, Powell tends to downplay the role of the dot plot and continues to emphasize waiting for certainty, abandoning expectation management, and choosing to retain flexibility to adjust monetary policy at any time in the future.

The team believes that evidence of how tariffs affect inflation can be seen in the inflation reports from June to August (released in July to September). If the inflation data from June to August shows that the transmission from core goods to service inflation is not obvious, the Federal Reserve is expected to restart rate cuts in October.

CSC's views are as follows:

In the June interest rate meeting, the Federal Reserve maintained the target range for the federal funds rate at 4.25%-4.5%. The dot plot predicts two rate cuts in 2025, consistent with the March dot plot, with one rate cut each in 2026 and 2027, and long-term rates unchanged. Among the 19 officials, 7 believe there will be no rate cuts this year. The Summary of Economic Projections (SEP) raised inflation and unemployment rate forecasts, with the median core PCE inflation forecasts for the end of 2025, 2026, and 2027 raised to 3.1% (+0.3pp), 2.4% (+0.2pp), and 2.1% (+0.1pp) respectively, and unemployment rates raised to 4.5% (+0.1pp), 4.5% (+0.2pp), and 4.4% (+0.1pp) respectively. During the same period, GDP growth expectations were lowered to 1.4% (-0.3pp), 1.6% (-0.2pp), and 1.8% (unchanged), and it was believed that the uncertainty of the economic outlook had diminished but remained at a high level.

The Federal Reserve's June interest rate meeting maintained its stance for the fourth consecutive month. Compared to March, the SEP raised inflation and unemployment rate expectations while lowering economic growth forecasts, and the dot plot maintained the prediction of two rate cuts within the year, but the number of officials expecting no rate cuts this year increased from 4 to 7.

The information released by the June dot plot and economic forecasts is consistent with recent public statements by officials: although officials generally expect inflation to rise, they believe it will ultimately fall back, the impact of tariffs on inflation will be one-time, and they expect the unemployment rate to rise. The policy rate is "moderately restrictive," but they still maintain a cautious attitude towards rate cuts, preferring to wait for clearer evidence of controllable inflation or a weakening labor market before cutting rates.

Powell similarly emphasized a similar monetary policy response function during the press conference: "Although this is the expectation, CSC cannot assume that the situation will be as such; CSC's job is to ensure that a one-time rise in inflation does not evolve into an inflation problem." This cautious stance may stem from the lessons learned by Federal Reserve officials from the post-pandemic inflation performance: whether inflation becomes a problem depends on the magnitude and duration of the inflation increase, rather than simply predicting that inflation is temporary based on the reasons driving it up While maintaining a cautious stance, Powell expressed a relatively optimistic view on other factors influencing interest rate cuts:

(1) He believes that the current unemployment rate remains low, and the labor market is experiencing a very, very slow and gradual cooling, but there is nothing concerning at the moment, which contrasts with the "unnecessary weakening of the labor market" when interest rate cuts began in September last year;

(2) When discussing the real estate market, he believes that the U.S. is facing a structural problem of long-term housing shortage, and the best thing the Federal Reserve can do for the real estate market is to restore price stability in a sustainable manner and create a strong labor market. This is a reason that the Federal Reserve typically emphasizes when maintaining a cautious stance of not cutting interest rates.

(3) He considers monetary policy to be "moderately restrictive" rather than "significantly restrictive," and believes that economic data shows that economic growth has not yet been strongly negatively impacted, thus allowing for a wait-and-see position.

Regarding the pace of interest rate cuts in the second half of the year, Powell tends to downplay the role of the dot plot, emphasizes uncertainty, abandons expectation management, and chooses to retain flexibility to adjust monetary policy at any time in the future.

Timing uncertainty: It is very, very difficult to say when confidence can change; it could be soon, or it may not be soon. At some point, things will become clear, but I cannot tell you when that will be.

Direction and degree uncertainty: Inflation may or may not reach the level that CSC believes, and the labor market may weaken or may not weaken.

Thus, the biggest obstacle to the Federal Reserve's interest rate cuts comes from the uncertainty of inflation—how tariffs translate into inflation, as well as timing and magnitude. When asked how to assess the impact of tariffs on inflation—including how long the lag is, how long it lasts, and the magnitude—Powell did not provide a guiding answer and continued to emphasize uncertainty: "Tariffs take some time to transmit to consumers, and manufacturers, exporters, importers, retailers, and consumers will all affect the ultimate degree to which tariffs push up inflation, and this process is difficult to predict."

CSC believes that the duration for tariffs to transmit to consumers is crucial for the timing of interest rate cuts in the second half of the year. From the literature, regarding the U.S.-China tariffs from 2018-19, tariff changes quickly transmitted to consumer prices within 2-3 months after the tariffs were implemented. For the fentanyl tariffs that began in February this year, they have already partially transmitted to consumer prices in March, pushing core goods PCE inflation up by 0.33 percentage points, leading to a 0.08 percentage point increase in core PCE inflation.

From policy announcement to importers: As of April this year, the U.S. effective tariff rate (defined as the tariff revenue received in the month / import value in the month) has risen from 2.5% at the beginning of the year to 7%. The effective tariff rate on China has increased from 10% at the beginning of the year to 37.5% in April. The effective tariff rate began to rise in the month following the tariff announcement, and most tariffs can gradually reflect in tariff revenue within 2-3 months after the tariff announcement.

From retailers to consumers: As the inventory accumulated before the tariffs is depleted, businesses will raise prices, leading to an increase in core goods inflation. The timing of inventory depletion and price increases will depend on each company's own decisions. CSC expects this process to be relatively quick, with some products, such as televisions, already having raised prices Therefore, CSC expects that the global equivalent tariffs, which will be imposed starting in April, will show data on how tariffs affect inflation in the inflation reports for June to August (to be released in July to September). Before the interest rate meeting in mid-September, if the inflation data from June to August shows that the transmission of core goods to service inflation is not significant, the Federal Reserve's confidence in inflation being transitory will increase, allowing for a restoration of forward guidance in the September Federal Reserve meeting and a resumption of interest rate cuts in October. However, if the labor market weakens or the time for retailers to deplete inventory is longer than usual, the timing for the Federal Reserve to resume interest rate cuts may be advanced or delayed.

Risk factors: In July, if trade negotiations between the U.S. and other countries and regions do not progress smoothly, leading to further escalation of Trump tariffs and the restoration of temporarily inactive parts of the equivalent tariffs, it may result in a significant increase in the overall effective tariff rate in the U.S.

The experience from the last round of trade wars becomes ineffective, as the depreciation of the dollar and rising inflation expectations lead to an increase in the transmission coefficient of tariffs to inflation, which may cause the transmission of core goods to service inflation to exceed expectations, thereby reducing the Federal Reserve's confidence in inflation being transitory.

Due to the import rush effect, the time required for inventory depletion is longer, further delaying the impact of tariffs on inflation, thus extending the period during which the Federal Reserve remains cautious.

If the labor market slows more than expected, the Federal Reserve may cut interest rates earlier