Fed to rebel against Trump but 'in a tough spot' over future policy easing

Following the unveiling of Trump’s tariffs on 2nd April, markets were quick to price in a more aggressive pace of US rate cuts in 2025 amid speculation that the trade restrictions would trigger a slowdown in the world’s largest economy. Not only are deals now starting to be signed (most notably with the EU and Japan), but this downturn is yet to materialise. US growth looks set to have rebounded solidly in Q2, following only a modest contraction in Q1.

The business activity PMIs are trending upwards, consumers appear resilient and the labour market is continuing to create jobs at a robust pace. All the while, US inflation jumped again in June, rising to a four-month high 2.7%.

All of this means that the Fed is all but certain to keep rates unchanged again this week, with futures markets pricing in effectively no chance of a cut. Chair Powell has repeatedly said that the bank is waiting for greater clarity on the state of the trade negotiations and the impact of the tariffs on the US economy, a sentiment that he is likely to repeat during Wednesday’s press conference.

While the tariffs look likely to have negative implications for US growth, they are also expected to be inflationary, even if only temporarily, which means that, without further evidence, neither the timing nor pace of cuts are particularly clear cut.”

The Fed is currently in a rather tough spot. One could argue that the growth risks posed by heightened trade uncertainty would warrant greater policy easing. Yet, with the latest economic data holding up quite well, and with the inflationary implications of the tariffs yet to fully materialise, we don’t think that policymakers are yet in a position to pull the trigger on lower rates, or even signal that rate cuts are imminent.

The adoption of a cautious, wait-and-see stance would, we believe, keep the door open to a September cut, while not firmly committing to one either.

As far as the FX reaction is concerned, remarks that talk up the strength of the US labour market, while expressing concerns over an overshoot in inflation, would likely buoy the dollar, particularly given the extent of the depreciation since the start of the year.

Conversely, we could see some downside in the greenback should Powell express confidence over the temporary nature of the tariff-induced inflation spike, while explicitly saying that the Fed would have learned a lot by the September meeting.