MNI INTERVIEW: Fed To Cut Just Once Due To Tariffs-Carpenter
MNI (WASHINGTON) - The Federal Reserve will likely only manage to cut interest rates once more this year because the upward drift on inflation from new U.S. tariffs will make additional reductions untenable, former Fed board economist Seth Carpenter told MNI.
Because inflation data are lagging, the next couple of months of readings are likely to be benign, giving the central bank room to ease again in May or June.
“Especially in the year-on-year numbers, which Chair Powell has referenced enthusiastically at the last FOMC meeting, we think you are going to see a continued decline in inflation, core inflation,” said Carpenter, former deputy director of monetary affairs at the Fed board, in the latest episode of MNI’s FedSpeak Podcast.
“So we are looking for one more rate cut in May or June of this year. The timing is hard to be sure about, because it depends on noisy data.”
By early summer, however, the inflationary effect of tariff hikes and immigration restrictions will create enough of a bump in key price indicators to force another prolonged pause, added Carpenter, now global chief economist at Morgan Stanley. (See MNI INTERVIEW: Fed To Stay Careful Amid Policy Turmoil-Johnson)
ON THE SIDELINES
“At some point, and it may happen in time for the June meeting but we think probably it happens a little bit later, inflation will start to pick up a bit from tariffs and other things and that’s going to be what puts them to the sidelines,” he said. “Maybe [the rate cut] doesn’t even happen at all if the inflationary pressures show up earlier.”
Carpenter then expects the Fed to remain on hold for the rest of 2025 and into 2026–until what he sees as the underappreciated drag on growth starts to truly rear its head.
“People need to be prepared for a hit to economic activity that might take two quarters instead of two months,” he said.
And it’s not just tariffs that will be retarding growth prospects, added Carpenter. “Making current tax policy permanent doesn’t stimulate the economy, but laying off a bunch of federal workers and cutting government agencies is austerity. That is contractionary.”
IT’S COMPLICATED
Fed officials are generally inclined to look at tariffs as a one-time shock to prices that they can “look through,” as they did in the 2018-2019 U.S.-China trade wars, said Carpenter.
Yet even as the Fed stays attuned to the risk of economic weakness, it must also remain cognizant of a new post-Covid price shock world where inflation expectations are likely to be more brittle because businesses and consumers have experienced sharp recent cost swings.
“We have lived through a very historic inflationary episode. Inflation is not back to Fed’s target, inflation has not been running below target like it had been in 2018 and so I think even if they believe with good reason that if the inflationary impact will be temporary, I don't know how they can have a lot of conviction in that,” said Carpenter.
That means they will need to see real evidence that there’s a significant slowdown in economic activity and that the disinflation process is back on track before any further easing.
“They have to see it start to develop in the data, so they will be necessarily pretty reactive, because inflation expectations, the whole inflation generating process, has been so upended, I don't think they can afford to take a risk that inflation really does just go away on its own,” he said.