Fed watchers expect no intervention for now as tariff detox continues

Massive volatility in financial markets triggered by President Donald Trump’s burgeoning trade war has raised speculation the Federal Reserve may intervene to stem the losses. Don’t count on it, several Fed watchers said.

With inflation still running above the US central bank’s target and levy-induced price hikes on the horizon, economists and market analysts said they believe Fed officials will wait for the impact to hit the real economy before they lower interest rates. That could take months to show up in official data.

“If we don’t get a recession, it’s going to be hard for the Fed to look through this inflation in the short run,” Michael Gapen, chief US economist for Morgan Stanley said Monday on Bloomberg TV. “The Fed’s going to be on hold for the foreseeable future.”

Fed officials have a track record of taking actions to stabilize markets and the economy during times of crisis. That’s sometimes meant emergency rate cuts between planned policy meetings to stave off the possibility of a severe recession. The last time the Fed did so came in March 2020 at the outset of pandemic-related shutdowns in the US. 

At one point on Monday, interest-rate swaps implied about a 40% chance the central bank would lower its benchmark rate 25 basis points by next week, well before the Fed’s next scheduled policy decision on May 6-7. Investors have since reduced that bet. 

At the moment, however, current economic data still point to a stable, if slowing, US economy. The March jobs report showed a labor market that was holding up well ahead of the tariffs, with monthly gains exceeding all forecasts.

Speaking Monday in Cambridge, Massachusetts, Fed Governor Adriana Kugler said the impact of tariffs had more pressing implications for inflation than for economic growth.

Market Stress

Officials have also used temporary lending facilities to prevent low liquidity from paralyzing credit markets. The Fed took that step in 2020, as well as in 2008 during the Great Financial Crisis.

And markets have clearly been under stress. On Monday stocks tumbled, taking the three-day wipe out in global equity value to roughly $10 trillion. Treasuries and the yen have gained as investors sought refuge, though US bonds slipped back Monday from their highs near the open to trade lower on the day, pushing yields up across the curve. Stocks on Tuesday mounted a turnaround, with Asian indexes closing higher and S&P 500 futures up more than 2% as of 7:43 a.m. in New York.

Still, the pain in financial markets hasn’t yet revealed bouts of illiquidity that might cause the Fed to intervene.

Meanwhile, the Fed’s favorite gauge of underyling inflation was 2.8% in the year through February — well above their 2% target — well before the latest tariffs had a chance to hit prices. Moreover, one measure of long-run inflation expectations — an important input to inflation that Fed officials watch closely — has slipped upward for three straight months.

That puts policymakers in a difficult position, according to former Fed Vice Chair Lael Brainard.

“They are going to want to lean against those inflationary pressures, and that gives them much less ability to come in to support the labor market before they see any signs of weakening,” Brainard said in an interview on CNBC. “So this is one of the most difficult scenarios for the Federal Reserve.”

A plunging stock market and gloomy outlook from businesses and consumers could portend a real slowdown. Some economists have said there are a greater odds for a global downturn if the tariffs are left in place.

Yet Fed Chair Jerome Powell signaled Friday the US central bank won’t rush to react to the market turmoil, saying officials have an “obligation” to keep inflation expectations stable. He said rates are well positioned, giving officials time to assess how Trump’s policies are hitting the economy.

Powell also said the economy was “still in a good place,” according to current data, and didn’t mention the ongoing stock market decline. 

What Bloomberg Economics Says:

“If the Fed believes it once again faces a risk that inflation expectations could de-anchor, then — as in 2022 — even a 20% drop in equities won’t deter it from keeping policy tight.”

—Anna Wong, economist. For full analysis, click here

One development that could spur the Fed into action would be any indication that Treasury markets, or other key parts of the financial system, are not functioning well.

“Unless there is any financial stability risk emanating from dysfunctional markets, I don’t really see, at this stage, the Fed stepping in,” said James Knightley, chief international economist at ING.

Darrell Duffie, a Stanford University finance professor said past research he’s conducted with New York Fed staffers showed Treasury liquidity does fall when macroeconomic volatility rises — as it’s done now. The type of market dysfunction that raises alarms and the need for support occurs when dealers become overwhelmed by market activity and can’t maintain their role as intermediaries. That’s not happening yet, said Duffie.

If those warning signs do appear, officials would likely respond with specific lending tools and not interest rates, some economists said. In March 2020, for example, policymakers launched an expansive bond-purchasing program when Treasury markets froze and introduced an emergency lending program for banks after the failure of Silicon Valley Bank in 2023.

“If financial strains become worse, the playbook here for the Fed is to address those directly rather than using interest rates to get into all the cracks,” said Lou Crandall, chief economist for Wrightson ICAP.

Others noted the Fed is limited in what it can do to ease concerns related to White House policy. “This isn’t something the Fed can fix,” said Brett Ryan, senior US economist at Deutsche Bank AG. “The circuit breaker here is the Trump administration and they’re not backing down, they’re doubling down and so you’re seeing the market react accordingly.”