The Fed’s Tough Spot: What to Expect from the May FOMC Meeting

Key Takeaways

• The Fed is likely to hold interest rates steady at its May meeting, with Trump’s tariffs having muddied the outlook for the economy.
• “Soft” economic data is deteriorating, but “hard” data still looks strong.
• With the tariff impact on the economy highly uncertain, markets expect a July interest rate cut, but some strategists say it could take longer.

While another interest rate pause looks like a foregone conclusion at this week’s Federal Reserve policy-setting meeting, the path forward is anybody’s guess. In the bond market, traders are betting that the Fed will lower interest rates in July. However, given the significant unknowns in the economic outlook resulting from President Donald Trump’s trade wars, the timing of interest rate cuts (if there are any this year at all) could change dramatically in the months ahead.

It’s an extremely unusual moment for the US and global economy. Since Fed officials last convened, there’s been a seismic shift in the outlook. Markets shuddered after Trump announced sweeping “reciprocal” tariffs on US trading partners on April 2. Economists generally agree that tariffs will impact the economy, though the scale of these effects will heavily depend on whether the announced rates are reduced. But forecasters say that even lower tariffs than what Trump has threatened will slow growth and raise inflation.

Such impacts will come as growth was already set to slow in the years after the pandemic rebound. But unlike during during the pandemic, analysts don’t expect the Fed to rush to slash rates. Inflation is higher than central bankers would like, and the impact of the tariffs is still highly uncertain, with trade negotiations ongoing and a 90-day pause on many levies still in effect.

So far, there has been little visible impact in the official government data, although figures on first-quarter gross domestic product growth showed the impact of companies rushing to import goods ahead of expected levies. While that sort of “hard” economic data has yet to reflect the direct impact of tariffs, “soft” data (such as consumer and business sentiment) has deteriorated sharply. That leaves the Fed in “wait and see” mode, with asset prices and investor expectations for monetary policy churning higher and lower on a daily basis in the absence of concrete information about the outlook.

The Fed Continues its Balancing Act

Markets celebrated a benign jobs report on Friday, which analysts said was a sign that Trump’s radical overhaul of US trade policy hasn’t yet dented the labor market. Strategists say that report will likely give central bankers the confidence to hold rates steady for another month. But in the months ahead, Fed officials will have to balance the twin risks of higher inflation and slowing growth—a tricky proposition.

“This is a very tough spot, because you’re seeing a stagflationary shock with the tariffs,” says Don Rissmiller, chief economist at Strategas. Tariffs will put upward pressure on prices, while the labor market is at risk as the economy slows. “That’s a problem for both mandates,” Rissmiller says. The Fed wants low and stable inflation alongside maximum employment. Higher inflation generally warrants tighter monetary policy to help slow the economy, while a slowing economy and a cooling labor market would call for lower interest rates and more stimulative policy.

Right now, it’s not clear which side of the dual mandate will deteriorate first, or how quickly. “How are they going to reconcile those things? The data is just not there yet, and so I think more time is warranted,” says Lindsay Rosner, head of multi-sector fixed-income investing at Goldman Sachs Asset Management. Rissmiller says inflation data tends to move more quickly than employment data, and it could show strain from tariffs earlier.

When Will the Fed Cut Interest Rates?

Bond futures traders and strategists are virtually certain the Fed will hold rates steady at a range of 4.25%-4.50% on Wednesday. Rates have been sitting in that range since last December. Futures markets see a roughly 28% chance of a cut at the Fed’s June meeting, down from 60% ahead of employment data released Friday. Markets now see a roughly 56% chance of a cut in July and are pricing in three rate cuts for the remainder of 2025.

Many also pushed out their expectations for cuts to July in the wake of the jobs report. But the positive momentum may not last. While Friday’s report showed sustained job growth that exceeded economists’ expectations, “it’s still quite unclear if current positive employment trends are sustainable given the impact of tariffs,” says Dominic Pappalardo, chief multi-asset strategist for Morningstar Investment Management. “A strong employment picture does nothing to alleviate the Fed’s inflation-related concerns and will likely prevent them from cutting rates sooner than expected.”

Rosner says the Fed will likely be prepared to cut rates if the labor market deteriorates quickly, even if inflation remains higher than its 2% target.

Hard vs. Soft Data

Rissmiller says the Fed’s focus on “hard” rather than “soft” data means cuts could come even later than July.

“Hard” economic data shows the measurable performance of the economy. It’s definitive, but also tends to be backwards-looking. “Soft” economic data tends to be based on sentiment and expectations. It can be more forward-looking, but sometimes sentiment doesn’t translate directly into performance. Right now, economists say there is a divide between the two. Consumers and businesses are pessimistic, but the economic slowdown they’re worried about hasn’t yet materialized in the hard numbers.

Central bankers have stressed that they will make policy decisions based on incoming economic data rather than less-than-concrete forecasts or sentiment indicators. Rissmiller expects Powell to stress again that Fed officials are taking hard data into consideration, not just soft data. Concerning hard data, the economy is looking okay in the second quarter so far. “They may need to see the next quarter of data that actually starts to weaken before they pull the trigger” to cut rates, Rissmiller says. “If they don’t cut in June, we may be talking October before the next opportunity comes up.”

In a Sunday note to clients, economists from Goldman Sachs said Fed officials are likely wary of the potential gap between hard and soft data and “will want to see evidence from labor market and other hard data before delivering rate cuts.” They also expect it will be a few more months before officials see enough evidence in the hard data to warrant a cut. Right now, Goldman Sachs is expecting three consecutive 0.25-percentage-point rate cuts in July, September, and October.

Uncertainty Remains High

Even as markets coalesce around expectations for three cuts for the remainder of the year, Rosner stresses that the range of potential outcomes remains wide. Policy surprises have upended market expectations this year, and markets still lack clarity on what tariffs will look like. “There are many paths this could all take,” she says. If inflation remains sticky while tariffs hurt growth less than expected, rates could stay steady for the rest of the year. But a trade war escalating and a recession emerging, prompting more aggressive rate cuts, is also on the table.

‘The idea that all of this is known and is going to be in this very clear, tight policy path—I think the market has moved on,” Rosner says.