If you're hoping a first-quarter contraction of the nation's economy will spur the Federal Reserve this week to hint that it could soon resume its market-friendly interest rate cuts, you may want to curb your enthusiasm.
Economists expect Fed officials to hold rates steady after a two-day meeting Wednesday and repeat that they're in no hurry to lower rates. They're likely to say they'll wait for further clarity as they struggle to navigate the effects of President Donald Trump's tariffs on their two key missions: keeping inflation low and employment high.
While U.S. gross domestic product technically shrank the first three months of the year, the economy fundamentally remains sturdy. On the other hand, inflation is still moderately above the Fed's 2% goal, with Trump's import duties set to propel prices higher.
Normally, a vibrant economy and job market push up inflation, prompting the Fed to raise its key rate or keep it higher for longer to cool activity. A slowing economy, or recession, typically constrains price increases and causes the central bank to cut rates to stimulate growth and hiring or dig the nation out of a downturn.
But Trump's sweeping tariffs are expected to sharply raise consumer prices and thus curtail household spending, presenting a worst-of-all worlds scenario known as stagflation that would leave the Fed torn between its two mandates. Consumption makes up 70% of economic activity and powers job growth.
In that event, Fed Chair Jerome Powell has said the Fed would assess which goal - stable prices or maximum employment - is furthest away and prioritize achieving it.
Wednesday, Powell will probably mention "that if the (Fed's) dual objectives come into conflict, (it) will likely adopt a balanced approach," Barclays wrote in a research note.
But Powell also suggested last month that all things equal, the Fed's "obligation is to keep longer-term inflation expectations anchored to make certain that a one time increase in the price level (from tariffs) does not become an ongoing inflation problem."
In a note to clients, Morgan Stanley wrote, "We expect the Fed to lean in the direction of emphasizing price stability."
Added Deutsche Bank: "We think the message will continue to be that the labor market will need to show signs of weakening before the (Fed) contemplates any further reductions in the policy rate. In other words, the Fed does not intend to deliver preemptive rate cuts as President Trump has recently called for."
Fed futures markets figure the Fed will start cutting rates again in July and approve three quarter-point cuts by the end of the year.
Other forecasters have grown warier. Barclays pushed its estimate of the first rate cut from June to July and expects just one more decrease in September. Morgan Stanley predicts no rate cuts until 2026 unless the economy tips into recession this year, as many forecasters expect.
The Fed slashed rates by a percentage point late in 2024 after a pandemic-related inflation spike eased but has paused since as the import levies threaten to reignite price hikes.
Here's why Fed officials could signal that they're inclined to wait longer to reduce rates:
To be sure, the economy shrank at an annual rate of 0.3% in the first quarter but that's because goods imports swelled an eye-popping 50% annualized as companies raced to order foreign merchandise before tariffs kicked in. Imports are subtracted from U.S. GDP because they're produced in other countries.
Goldman Sachs expects that effect to reverse in the second quarter, boosting growth.
Meanwhile, consumer spending increased a solid 1.8% and business investment leaped 22.5%, underscoring the economy's pillars are still strong. Final sales to domestic purchasers, which excludes trade and inventories, grew a healthy 2.3%, Morgan Stanley noted.
Some of the consumer and business purchases were also aimed at getting ahead of tariffs, economists noted. Still, the demand from households and companies was there.
Meanwhile, U.S. employers added a robust 177,000 jobs in April and an average 155,000 the past three months. Unemployment sits at a historically low 4.2%.
"The Fed is likely to look through some of the noise in the quarterly GDP data brought on by trade policy uncertainty," Morgan Stanley said.
Inflation also softened in March. The Fed's preferred overall inflation measure dipped from 2.5% to 2.3% and a key reading that strips out volatile food and energy items fell from 2.8% to 2.6%.
That's encouraging but it means inflation is still well above the Fed's 2% target.
"The Fed's attention will be on inflation as it remains the furthest from its objective," Oxford Economics said in a research note.
Also, forecasters expect tariffs to drive inflation much higher by midyear.
"Given the tariffs now in place, we expect inflation to pick up significantly in coming months," Barclays wrote to clients.
The research firm estimates core inflation will peak at 3.8% in 2025.
Although consumer and business confidence have tumbled amid the flurry of Trump's tariff announcements and the resulting stock market sell-off, sentiment also fell dramatically when the Fed hiked interest rates sharply in 2022 and 2023. But that didn't lead to a recession, casting doubt on the value of the polls, economists say.
Fed officials "will want to see evidence from labor market and other hard data before delivering rate cuts," Goldman Sachs said.
John Williams, head of the Federal Reserve Bank of New York and a voting member of the Fed's policymaking committee, said he expects inflation to rise to 3.5% to 4% this year. Then, he expects unemployment to climb to 4.5% to 5% "over the next year," according to Morgan Stanley.
"It wilI be hard for the Fed to" cut rates to head off a potential labor market slump "if inflation is rising first and is further from its target than employment is", Morgan Stanley said.
Trump's deportations of hundreds of thousands of immigrants who lack permanent legal status this year are likely to slow growth in the labor supply. Fewer people looking for jobs means the unemployment rate could rise more gradually even as hiring slows and layoffs spread, making it harder for the Fed to cut rates, especially with inflation heating up, Morgan Stanley said.
Goldman Sachs, however, believes the Fed could move sooner and more forcefully to reduce rates. Intensifying business uncertainty could lead to less hiring, more layoffs "and the first signs of weakness in the May employment report," Goldman said. Meanwhile, businesses' worries should lead to fewer job openings and less capital spending within a couple of months.
Goldman thinks the Fed will start cutting rates in July and lower rates three times this year.