All Eyes on Powell: Will the Fed Blink Amid Economic Crosswinds?

TradingKey - The Federal Reserve is set to announce its latest interest rate decision this Thursday (ET). According to the CME FedWatch Tool, markets now assign a 97% probability that the Fed will hold rates steady this month.

However, markets don’t expect the pause to last much longer. LSEG data shows that the federal funds futures market now prices in nearly an 80% chance that the Fed could resume rate cuts as early as its July meeting.

Macro Landscape: Recession Alarms Meet Persistent Inflation

Q1 2025, U.S. GDP contracted at an annualized rate of -0.3%, marking the first negative print since 2022 and a sharp reversal from the previous quarter's growth of 3.4%. The weak reading has renewed recession fears.

One of the key drivers behind the contraction was a front-loading of imports by businesses anticipating potential new tariffs under a second Trump administration. This led to inventory buildup and a drag of 1.9 percentage points from net exports. The demand brought forward during this buying spree suggests potential weakness ahead. Meanwhile, saving rates rose from 3,9% to 4.1%, and the consumer confidence index fell to its lowest level in nearly five years, signaling declining sentiment.

Source: Yardeni Research

On inflation, March data showed that the core PCE price index rose 2.3% year-on-year, moving closer to the Fed's 2% target. However, the 6-month annualized core inflation rate remains elevated at 3.2%. Service inflation excluding housing and energy dropped to its lowest level since 2020, suggesting some easing in demand. Yet, price pressures stemming from higher tariffs on imported goods remain a looming risk.

Then there’s the job market—the Fed’s key focus—which is showing mixed signals.

April’s ADP report showed a sharp slowdown in hiring, with just 62,000 new jobs versus forecasts of 147,000. Big names like UPS are cutting jobs, blaming tariffs and softening demand. The unemployment rate is steady at 3.8%, but fewer people are participating in the job market and wage growth is cooling—signs of weakening momentum.

That said, April’s nonfarm payrolls surprised to the upside, adding 177,000 jobs. So the labor market isn’t collapsing—at least not yet.

A report from Challenger, Gray & Christmas shows that government-related sectors have already cut over 282,000 jobs in 2025, the highest of any sector so far. Most cuts are tied to actions linked to “DOGE” initiatives. Economists warn that federal budget cuts could ripple further, potentially impacting up to half a million jobs in contractors, universities, and other organizations reliant on government support.

Source: Challenger, Gray & Christmas

Nick Timiraos from the Wall Street Journal—often dubbed the “Fed whisperer”—recently highlighted that the Fed is stuck in a tough spot: trying to fight inflation while guarding against a recession. Right now, the bias is toward caution. They’re watching labor numbers closely.

Fed Policy Independence at a Crossroads: Politics vs. Economics

With GDP turning negative and consumer confidence deteriorating, signs of a "technical recession" are emerging. Goldman Sachs’ recession probability model suggests that the odds of the U.S. economy falling into recession in Q3 2025 could rise to 65% if current rates remain unchanged.

Meanwhile, President Donald Trump continues to publicly pressure the Fed to cut rates, arguing it is essential to support the housing market and consumer spending. His proposed tariff plan has already caused economic ripples—driving up import costs, prompting layoffs, and stoking inflation—indirectly placing greater strain on Fed policy.

But Jerome Powell isn’t blinking. The Fed Chair has made it clear that they’d rather risk staying tight for too long than cut too early and lose control of inflation..

Jan Hatzius, Chief U.S. Economist at Goldman Sachs, echoed this view, saying:  “We think it will take a couple of months for enough hard data evidence to accumulate to make the case for a cut.”  Goldman Sachs expects the Fed to deliver 25-basis-point cuts in July, September, and October.

Can Rate Cuts Offset the Effects of Tariffs?

The inflationary impact of tariffs is already working its way through the consumer economy. Procter & Gamble recently raised prices on products such as detergents and diapers by 12%–15%. Amazon increased its FBA logistics fees by 20%. Apparel prices at Temu and Shein rose by an average of 8.5%, while some electronics sold via TikTok Shop now carry a 25% premium.

Goldman Sachs warned that if the new round of tariffs is fully implemented, U.S. core PCE inflation could rise to 3.5% by the end of 2025.

In this environment, if the Fed eases too quickly, markets and businesses could see it as a green light to keep raising prices—interpreting it as the Fed “looking past” inflation and effectively tolerating higher prices. That could spark a second wave of inflation.

Nick Vyas, Founding Director of the Global Supply Chain Institute at USC’s Marshall School of Business, warns that rising prices could seriously dampen consumer spending in peak shopping seasons: “We’re approaching a tipping point,” Vyas said. “Companies under pressure may start reworking their supply chains. The result? Higher costs that monetary policy alone can’t fix.”

In the short term, cutting rates may give markets a relief rally. But it won’t fix the deeper structural issues—like broken supply chains or rising import costs due to tariffs. If things spiral far enough, some fear we could see ruptures in global supply chains similar to the 1930s Depression.

And should a full-blown recession take hold, the Fed may find it has little ammunition left to stimulate an already fragile economy.