Featured Insights

As was widely expected, the Fed continued to hold interest rates steady in its May meeting. While their messaging was little changed, there was a notable tweak to their statement, which emphasized the growing uncertainty surrounding both of their mandates – inflation risks are intensifying following the implementation of [higher than expected] tariffs and the risks to unemployment are climbing as the economy shows signs of slowing. Still, the Fed expressed confidence in its current policy stance as it awaits to see the impacts of trade policies on the economy in the months ahead.

“[…] as we noted in our statement, we have judged that the risks to higher employment and higher inflation have both risen and this, by the way, of course, is compared to March… I think there’s a great deal of uncertainty about, for example, where tariff policies are going to settle out and also when they do settle out, what will be the implications for the economy, for growth, and for employment… ultimately, we think our policy rate is in a good place to stay as we await further clarity on tariffs and ultimately their implications for the economy.”

The Fed expressed a significant amount of uncertainty as trade policy remains unclear

What’s interesting is that Powell remains very non-committal as to which side of the dual mandate will bear more weight. If indeed they’re in tension, the Fed will look at how far they are from the respective goals and the time horizon at which the gaps will close. But for now, the Fed has made no indication as to what or when their next decision will be as they continue to monitor the economic data. A significant challenge is the conflicting signals we are seeing in the most recent hard data: downward revisions to February and March payrolls suggest a softer labor market, yet the unemployment rate held steady at 4.2%. Headline GDP growth was negative (primarily a result of tariff frontrunning), yet strong private domestic final purchases (PDFP) suggested U.S. consumers remain resilient. For now, the Fed will continue to wait and see how the economy evolves during the trade negotiations as Powell stated, “we actually don’t know what the right response to the data will be until we see more data.”

But the Fed’s current confidence presents a risk that they could fall behind the ball

Despite Chair Powell citing significant uncertainty surrounding timing, scope, scale, and persistence of the effects of tariffs, he continued to insist that the Fed is “[…] well-positioned to wait for greater clarify before making any adjustments.” While this stance may seem reasonable for the immediate term, we expect tariff impacts will begin appearing in the inflation data soon, while growth deterioration and labor market weakness will follow with a lag. And excessive patience could impede the Fed’s progress towards its goals. Powell himself acknowledged that the soft-landing path could be jeopardized if higher inflation and unemployment risks materialize. If the FOMC delays its response too long, it risks undermining their progress towards returning to target objectives. And so we worry that Powell’s current wait and see approach may lead to more significant risks in the long term if inflation or unemployment rise more rapidly than expected.

“Look at the state of the economy. The labor market is solid. Inflation is low. We can afford to be patient as things unfold. There’s no real cost to our waiting at this point.”

What we are watching in the coming months

For now, we continue to monitor the yellow flags that have arisen following the April tariff announcements, including heightened inflation expectations and anemic consumer sentiment data as well as mounting consumer debt worsened by a growing student loan burden. Our most recent forecast update, which assumes elevated tariffs will remain in place, reflects an economy moving towards a stagflationary environment – we expect core inflation will crest above 4.0% and the unemployment rate could hit 4.8% by year-end. The question will be which mandate the Fed will choose to address. According to Powell “It’s a very challenging question. Now, there can be a case in which one goal is very far, one variable is very far from its goal, much farther than the other, and if so, you concentrate on that one.” Inherently, we presume it will be the labor mandate, as we expect the Fed to start a cutting cycle by September.

Mike Reid is a Senior U.S. Economist at RBC. He is responsible for generating RBC’s U.S. economic outlook, providing commentary on macro indicators, and producing written analysis around the economic backdrop.

Carrie Freestone is a member of the macroeconomic analysis group and is responsible for examining key economic trends including consumer spending, labour markets, GDP, and inflation.