Tariff turmoil and the Fed: A stagflation minefield

[CLAREMONT, CALIFORNIA] After a prolonged period of interest rate hikes to curb inflation, the Federal Reserve held the federal funds rate at a two-decade high of 5.5 per cent from July 2023 to August 2024. As inflation began to ease, the Fed shifted course, cutting rates three times between August and December 2024, bringing the target range down to 4.25 to 4.5 per cent to support growth and employment.

Just as monetary policy was turning more accommodative, fresh risks emerged. The reintroduction of tariffs under US President Donald Trump’s trade policies has considerably complicated the inflation and growth outlook. Following the 100-basis-point reduction, the Federal Open Market Committee (FOMC) chose to pause further rate cuts in January 2025, signalling a shift in strategy.

Stagflation risks: Trade and labour disruptions

Typically, central banks do not react to one-off tariff increases since their impact on prices is usually temporary. The US, as a large market and price setter, tends to experience milder effects from such policy changes compared to economies that are price takers.