Job creation and inflation are key to rate cuts

The fog of trade wars has made it difficult to discern what’s going on in the U.S. economy.

Is inflation going to speed up again? Are businesses going to stop hiring? Are people going to cut spending? So many questions for Federal Reserve officials, but so few answers ahead of their meeting this week.

Call it the fog of war — in this case, trade war.

The Trump administration has reduced economy-threatening tariffs to more manageable levels, but the U.S. still hasn’t reached trade deals with most other countries. The simmering disputes have sapped consumer confidence and made it hard for businesses to plan and invest.

Adding to the confusion just days before top Fed officials meet is an actual war between Israel and Iran that threatens to raise oil prices. Higher energy prices could also add to inflation and hurt the U.S. economy.

“The economy has slowed and is vulnerable to anything else going wrong, including a sudden and persistent increase in oil prices,” economists at Oxford Economics wrote in a note to clients.

What do most people do when they’re stuck in fog? They wait for it to clear.

Fed officials have signaled ahead of their two-day meeting this week that they are likely to leave interest rates unchanged. They want to see more evidence of how well the economy is coping with the current conflicts before making any big move.

“Bottom line, the bar that leads to Fed rate action remains high,” said Sam Bullard, senior economist at Wells Fargo.

The economy has clearly suffered a blow from the trade wars, however.

The most visible sign was a contraction in gross domestic product in the first quarter, for the first time in three years.

Yet the reason GPD shrank was because businesses acted to stock up on imports before the tariffs took effect.

Consumers did the same thing. They bought lots of cars in March and April to beat the tariffs, for instance, and drove up sales to a four-year high. Then vehicle sales sank 10% in May as tariffs kicked in.

The stop-and-start trade wars have effectively have created a stop-and-go economy — one subject to the whims of the president and what he says on any given day about U.S. trade strategy.

The uncertainty about global trade rules going forward has thickened the fog around the economy, cementing the Fed’s wait-and-see approach.

Yet central-bank officials still have to do their best to predict the likely path of the economy. And they will do that at the June meeting by releasing the updated projections they publish four times a year.

In March, the Fed projected GDP growth would slow to 1.7% in 2025 from just under 3% in both 2024 and 2023. Now the central bank is expected to dial back its growth forecast yet again.

By how much? A new poll of top Wall Street economists lowered its 2025 GDP forecast to 1.3% from close to 2% before the trade wars began in March.

Slower economic growth, in turn, is expected to hobble U.S. job creation and nudge up the unemployment rate.

The Fed a few months ago saw the jobless rate rising to 4.4% by the end of 2025 from the current 4.2% level. The new update could reveal the situation to be potentially worse.

The good news so far? Inflation has stayed low since the trade wars erupted, opening the door for Fed interest-rate cuts later this year.

The rate of inflation using the Fed’s preferred personal consumption expenditures price index stood at 2.2% in April, not far from the Fed’s 2% long-run goal.

Fed officials predicted in March that inflation would rise to 2.7% by year-end. If they raise the forecast again, the Fed would have little leeway to proceed with the two rate cuts that Wall Street is betting on for this year.

Stay tuned. The new forecast will tell us a lot about what Fed officials think will happen this year as they try to look through the fog.