During the June policy meeting, the Federal Reserve, as expected, decided to keep the policy interest rate unchanged while downgrading economic growth forecasts, raising unemployment expectations, and adjusting inflation expectations upward. Essentially, this was a repeat of the actions taken during the March meeting, which led the market to label it as “Same Old, Same Old!”
Given that this was the Federal Reserve’s first forecast after the “Liberation Day tariffs,” it attracted more attention from the market. Compared to the last interest rate cut at the end of last year, the Federal Reserve has become more pessimistic about the U.S. economic outlook. The forecast for 2025 economic growth has been reduced by 0.7 percentage points to 1.4%, and inflation concerns have increased, with the PCE inflation forecast raised by 0.5 percentage points to 3%. The Fed has also continued to raise its baseline policy interest rate expectations, increasing the forecast for 2026 and 2027 by 25 basis points.
The main reason behind the Fed’s pessimism is undoubtedly the poor governance performance of the Trump administration. In early April, Trump announced irrational tariff policies, followed by a quick de-escalation and ceasefire, but no trade agreements have been reached so far. Global financial markets, having endured the rollercoaster effects of tariff battles, have reached a state of “fatigue.” The market’s main focus has shifted from the “Trump Trade” to “TACO” trading (Trump Always Chickens Out). The poor governance of the Trump administration has shaken market faith in the U.S. dollar. The long-standing risk balance relationship between U.S. stocks, bonds, and the dollar has been severely disrupted. The dollar index, which was above 110 at the start of the year, has fallen to around 97, down more than 10%; the 30-year U.S. Treasury yield has surpassed 5%.
The Trump administration’s poor governance and its impact on market expectations have severely affected the Fed’s efforts to manage inflation. Although the absolute price increase in the U.S. has been noticeably controlled, with the PCE and core PCE inflation rates remaining between 2% and 3% for 15 consecutive months, inflation expectations for U.S. residents have rapidly risen over the past three months. According to a Michigan University survey, the one-year inflation expectation has risen to 6.6%, the highest since 1981, and the five-year inflation expectation has reached a historic high of 4.4%.
The significant shift in inflation expectations has forced the Fed to proceed cautiously to prevent inflation from derailing again. Additionally, the U.S. labor market’s hard data remains resilient. While the number of people continuously filing for unemployment benefits has risen to 1.95 million, higher than the 1.87 million at the start of the year and the 1.83 million of the previous year, it is still below the levels seen during the first term of “Trump and Powell” (2025 vs. 2017). Moreover, the number of job openings is currently better than it was in 2017. Thus, while the U.S. labor market shows signs of slowing down, it has not yet reached the worst conditions experienced by “Trump and Powell” in the past. Therefore, even though U.S. consumer confidence has dropped to around 50, down by more than 20 points from before Trump’s tenure, the Fed can only continue to maintain restrictive interest rate policies.
In the face of extreme uncertainty and an unstable policy environment under Trump (“TACO”), the Fed and Powell can only temporarily remain as bystanders. At the press conference after the June meeting, Powell stated that it will take time to assess who the elevated tariffs will affect (manufacturers, importers, exporters, retailers, and consumers), the degree of impact, and how long the impact will last. The additional geopolitical tensions from Russia-Ukraine, India-Pakistan, and Israel-Iran conflicts make it even harder to predict the effects on the supply chain.
However, how long can the Fed continue to “watch from the sidelines”? The economic uncertainty, combined with the cost increases brought on by tariffs, could squeeze corporate profits, leading to rising unemployment and possibly even a recession. Moreover, the recent slowdown in the U.S. real estate market has already shown the negative effects of the current restrictive interest rate policies on interest-sensitive sectors. Therefore, the window for the Fed to remain as a bystander is not expected to be long.