President Trump’s on-again, off-again tariffs are wreaking havoc in the financial market and putting the Federal Reserve (Fed) in a tough spot.
The economic data released in March was largely bullish. The Consumer Price Index showed inflation slowing to just 2.4% in the 12 months through March, which was better than the 2.6% that many economists forecast. Meanwhile, non-farm payrolls jumped by 228,000, topping expectations and more than offsetting downward revisions in February.
With cooling inflation and a strong job market, these statistics might support continued rate cuts from 4.5% today toward the central bank’s 2% long-term target rate, especially if the Fed sees further disinflation and no signs of overheating in labor markets.
But a brewing trade war threw a wrench into the decision-making process.
Trump’s Stunning Tariffs
In early April 2025, President Trump stunned the markets by announcing a 34% tariff increase on China and a universal 10% baseline tariff — plus certain additional country-specific tariffs — for all non-USMCA countries. These actions brought tariff levels back to those last seen in the 1920s and sparked concerns of inflation and a recession.
On April 9, the stock markets plummeted around the world, while the U.S Treasury yields paradoxically rose sharply higher despite being a safe-haven asset class. President Trump reversed course midday by pausing tariffs on all countries except China and then increasing its tariffs on Chinese goods to 125%.
The reversal eased some concerns because manufacturers can pivot away from China or use intermediary countries to avoid onerous tariffs. However, Chinese manufacturing still accounts for $400 billion worth of goods purchased by U.S. consumers. And companies will be faced with a decision to cut profits or pass on costs to consumers.
Impacts on Inflation & Jobs
The Fed has a dual mandate to consider inflation and the job market when making monetary policy decisions. While March economic data may pave the way for a straightforward decision, President Trump’s trade war could complicate that decision by raising inflation and potentially triggering a recession.
According to a Boston Fed study, tariffs of 60% on China and 10% on the rest of the world — President Trump’s original promise during his campaign — could contribute as much as 2.2% to core inflation. That’s because about six percent of non-food and energy-related household spending is directly imported, and another four percent is indirectly imported.
Tariffs could also have an impact on the job market. Manufacturers could see higher input costs thanks to tariffs on imported goods, which could compress profit margins and lead to fewer new hires. While tariffs help protect some industries, a study from the Richmond Fed reported a net job loss during the last round of tariffs between 2016 and 2020.
What the Futures Market Says
Inflation has come down significantly since the beginning of the year, falling from 3.0% in January 2025 to 2.4% in March 2025. As a result, the futures market had projected a significant decline in interest rates by year-end, from an expected 400 to 425 basis point target range in February to a 325 to 350 range by March, before the trade war began.
Interest rate expectations from futures traders over time. Source: CME FedWatch
After the new tariffs were announced, the market shifted to a projection of 350 to 375 basis points from its previous reading of 325 to 350 basis points. More tellingly, the odds of a 375 to 400 basis point range shot up from just over seven percent to nearly a one-in-four chance. These trends reflect a growing sense of uncertainty in the market.
The uncertainty stems from the fact that the Fed will have to choose between containing inflation with elevated interest rates and supporting the economy with lower interest rates. Of course, the nightmare scenario is stagflation, with high inflation and stagnant economic growth, leaving the central bank with few options.
Beyond Interest Rates
The Fed could face additional problems with its balance sheet. Last month, the central bank dramatically decelerated the pace of its balance sheet drawdown despite internal opposition to the move. Officials made the decision based on the need to hedge uncertainty surrounding how soon Congress would raise the federal debt ceiling.
However, following President Trump’s tariff announcement, the Treasury sell-off sparked new concerns. A more prolonged or severe sell-off in Treasuries could force the Fed to reverse course and step in with emergency purchases to stabilize the market, reversing its balance sheet drawdown efforts in recent months.
The Bottom Line
The Fed is facing the same problem as investors in today’s market — predicting where Trump’s tariff whims are headed next. But historically, high tariffs have led to higher inflation and net job losses, which puts the Federal Reserve in a tough spot when it comes to setting interest rates and using its other monetary policy tools.
