The Federal Reserve probably will be more inclined to cut interest rates now that President Donald Trump has followed through on his threat to increase tariffs on U.S. imports from China. But it won’t rush into doing so.
While the higher levies will put upward pressure on inflation by raising import prices, the central bank will likely be more attentive to the potential drag they’ll exert on the economy by depressing consumer and business spending, Fed watchers said.
“We would expect the Fed to initially focus on the growth implication and look past the inflation impact,’’ Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, said in a May 7 note to clients.
Read More: Trump Says No Rush for China Deal as Tariffs Rise, Talks Resume
Fed funds futures on Friday showed traders are fully pricing in a cut within the first few months of next year. That’s several months earlier than it was indicating a week ago, before Trump’s weekend tweets on tariffs. Meanwhile, a key part of the Treasury yield curve that many see as a recession sign, briefly went negative on Thursday.
Federal Reserve Bank of Atlanta President Raphael Bostic told reporters on Friday that the central bank could reduce rates if the higher tariffs prompt a severe cutback in consumer spending.
“If this becomes prolonged and the extra cost gets fully passed on to consumers such that they pull back in a number of different ways, then that may mean we have a different calculus that we have to do to decide what appropriate policy looks like,” he said in Meridian, Mississippi.
On its own, the increase in import levies to 25% from 10% on $200 billion of Chinese goods shouldn’t have that much of an impact on U.S. gross domestic product. Feroli reckoned that the direct hit to growth would be about 0.2 percentage point.
What will be critical for the economy and the Fed is how the financial markets react to the heightened trade tensions and how that response -- and the uncertainty surrounding the issue -- affects business confidence and investment, according to Deutsche Bank Securities chief economist Peter Hooper.
Equity markets slumped this week as investors’ hopes for a trade deal dimmed. Overall financial conditions though remain supportive of growth, albeit less so than they were a week ago.