If recession becomes a reality, the Fed may be forced to cut interest rates in June

Source: Jinshi Data

The Federal Reserve will not cut interest rates at next week's policy meeting, but if growing concerns about a trade war-induced recession come true, the Fed may launch a series of rapid rate cuts in June.

At least that's the bet in the futures market. After U.S. President Trump's speech last weekend about the "transition period" of the economy, June, July and October contracts tied to the Fed's policy rate are increasingly pricing in a 25 basis point rate cut. U.S. stocks and Treasury yields also plunged on Monday due to concerns that Trump's comments foreshadowed an impending recession.

Federal Reserve Chairman Powell said on Friday that the Fed is in no hurry to cut interest rates because the labor market remains strong, inflation is bumpy on the road to its 2% target, and there is great uncertainty about the impact of Trump's trade, fiscal, immigration and regulatory policies. Economists say these policies could push up prices and slow economic development, at least in the short term. Goldman Sachs economists on Monday lowered their U.S. economic growth forecast to 1.7% and raised their inflation forecasts.

Situation could force the Fed to make a difficult choice between keeping its policy rate at its current range of 4.25%-4.50% to keep pressure on inflation, or cutting rates to ease a deterioration in the labor market.

While markets are betting on the latter, some economists see the Fed slowing its pace of rate cuts to prevent tariff-induced price increases from spurring inflation expectations among households and businesses, which could deepen the likelihood of persistently higher actual inflation.

“Despite the Fed’s calm exterior, (policymakers) are increasingly anxious that if labor or financial markets start to falter before the Fed has a chance to assess the inflationary impact of tariffs and the full range of Trump’s policies, the Fed would face rising risks to both inflation and employment, as well as the problem of resisting pressure from Trump to cut rates,” Tim Duy, chief U.S. economist at SGH Macro Advisors, wrote in a note.

The Fed has kept its policy rate unchanged this year after cutting it by a full percentage point in 2024. Policymakers will have more data to sift through this week, with a job openings report on Tuesday and the February consumer price index on Wednesday.

New York Fed: Inflation expectations steady, concerns about outlook grow

Americans' concerns about the economic outlook grew in February, even as their expectations about the future path of inflation did not change much, according to a report released Monday by the New York Federal Reserve.

According to the bank's latest Consumer Expectations Survey, inflation expectations in one year are at 3.1%, up slightly from 3% in January, while inflation expectations in three and five years are unchanged from January at 3%. The Fed wants inflation to fall to 2%.

The Fed's relatively calm outlook on inflation contrasts with expectations for faster price increases for food, rent, gasoline, college and health care costs, and a 3.3% increase in house prices. Uncertainty about the inflation outlook has also risen. The Fed's data contrasts somewhat with other recent reports that have shown a significant increase in expectations for future price increases.

The New York Fed report noted that "households expressed more pessimism about their financial situation over the next year in February, with a notable deterioration in expectations for unemployment, delinquency rates, and access to credit," even as respondents raised their spending expectations. The survey found that while households’ assessment of their current financial situation had changed little, their outlook for the year ahead had “deteriorated substantially,” with the highest share of households expecting worse conditions since November 2023.

Economists generally agree that Trump’s policies, if maintained, could push up inflation beyond levels that Fed officials already believe are too high, while curbing economic growth and pushing up unemployment in the future. Fears of a recession are rising across North America, according to a Reuters poll.

The outlook presents a major conundrum for the Fed because as of December the central bank had been expecting to cut its interest rate target further this year. Now, Fed officials could face an environment of rising inflation and a weak economy, both of which could be opposing sides of their rate choices.