During a recent address to the Economic Club of Chicago, Federal Reserve Board Chair Jerome H. Powell stated that President Donald Trump’s tariffs are "highly likely" to trigger a temporary increase in inflation. Powell cautioned that these inflationary effects could potentially be more persistent, leading to significant market reactions. Following Powell's remarks, the stock market experienced a notable downturn, with the Dow Jones Industrial Average dropping approximately 700 points, or 1.7 percent, and the S&P 500 falling by 2.2 percent. The Nasdaq composite index, heavily impacted by the ongoing trade war, decreased by 3 percent.
Investor anxiety grew throughout Powell's speech, largely due to the uncertainty surrounding the duration of the anticipated inflation. Chip manufacturers Nvidia and AMD reported in their company filings that Trump’s recent executive orders would necessitate substantial write-downs of their chip values, resulting in their share prices plummeting by approximately 7 percent.
Powell indicated that many of the administration’s policies—including those on trade, immigration, fiscal matters, and regulation—are still in flux. He highlighted that the increasing inflation and potential for slower economic growth could hinder the Federal Reserve's objectives of maintaining stable prices and fostering a robust job market. Supply chain disruptions stemming from the trade war could lead to prolonged price hikes, suggesting that the economic landscape could diverge significantly from the Fed’s goals.
Powell remarked, “I do think we’ll be moving away from those goals probably for the balance of this year, or at least not making any progress.” He noted that as the Fed adjusts interest rates, it may face a scenario where its dual mandates—ensuring stable prices and achieving maximum employment—are at odds. Typically, the Fed raises interest rates to combat inflation, making loans costlier, while it lowers rates to stimulate a slowing economy. The challenge arises when inflation rises amid broader economic downturns.
Powell acknowledged that while this situation is not currently a reality, it remains a possibility. He emphasized that minor job losses or anticipated price increases would likely not compel the Fed to take immediate action. However, it is still too early to gauge how the job market will respond to potential cuts in government workforce and federal funding.
Powell’s stark warnings arrive at a time when the economy and the Fed face yet another phase of uncertainty. After soaring to four-decade highs, inflation has been gradually moving toward a more stable target of 2 percent. Officials had held optimism that they were nearing a "soft landing," where inflation normalizes, the job market remains strong, and economic growth continues. However, this trajectory is threatened by Trump’s trade policies and the pervasive uncertainty affecting both businesses and financial markets.
For instance, sentiment among home builders has been declining for months, remaining low as of April. Powell noted that in discussions with business owners, he frequently hears that the level of uncertainty is unprecedented in their lifetimes, which could lead to reduced investment and hiring or even layoffs.
Simultaneously, financial markets have been reeling, with the Nasdaq composite index down over 15 percent for the year, and the S&P 500 down 10 percent. Investors are also moving away from Treasurys and the dollar, typically considered safe havens during market volatility. Powell stated that while markets are reacting as anticipated amidst such uncertainty, they continue to function safely.
Fed officials have consistently indicated that their outlook is contingent on how Trump’s policies unfold. The unpredictability of policies, which can change within days, complicates forecasting. Recently, the White House suspended many steep import tariffs for 90 days while increasing tariffs on China, maintaining a baseline 10 percent tariff on most imports and continuing tariffs on steel, aluminum, and autos.
This shift led many forecasters to temper their recession predictions, although the possibility remains. Earlier this week, Fed Governor Christopher Waller described the new tariff policies as one of the most significant shocks to the U.S. economy in decades. While the effects on prices could be steep, Waller suggested that they may not be permanent, provided long-term price expectations remain stable. Nevertheless, aggressive tariff policies could slow growth to a crawl and increase unemployment rates.
Ultimately, Fed officials will need to differentiate between short-term changes, such as temporary price increases, and longer-lasting impacts, including sustained inflation or economic slowdowns. This distinction is essential as the Fed aims to maintain the long-term health of the economy rather than react impulsively to transient data fluctuations.
Although the job market remains solid with an unemployment rate of 4.2 percent, and the Fed’s preferred inflation gauge stood at 2.5 percent in February, other troubling indicators are emerging. Retail sales surged in March, driven by consumers panic-buying ahead of impending tariffs, while industrial production witnessed its first decline in four months.
Since the initiation of the trade war, stock markets have shown signs of distress. President Trump has publicly urged the Fed to lower interest rates to stimulate economic growth, but the Fed is committed to maintaining its independence from political influence. Trump has historically disregarded these norms, recently admonishing Powell to “stop playing politics!” in an online post, urging the Fed to act decisively in response to the current economic challenges.
