Key takeaways from the Fed’s latest decision to hold rates steady as it warns of stagflation

By Bryan Mena, CNN

Washington (CNN) — The Federal Reserve said Wednesday it will hold interest rates steady as the US economy begins to show the effects of President Donald Trump’s haphazard trade war.

The central bank kept its benchmark lending rate unchanged at a range of 4.25% to 4.5%, extending a holding pattern that began in January.

Officials have said it’s best to wait on the sidelines for data to show how the US economy is responding to Trump’s significant policy changes, though the Fed said in its latest policy statement that the “risks of higher unemployment and higher inflation have risen” — a toxic duo known as stagflation.

Fed Chair Jerome Powell in a news conference said that uncertainty is pervasive, from where policy is headed to how the economy will evolve in the face of Trump’s ongoing trade spat with the world. He also reiterated the growing threat of stagflation, but said America’s labor market remains a reassuring bright spot in the economy.

Trump’s whipsawing tariffs have already taken a toll on economic growth, which Powell attributed to a surge in imports. The US economy contracted in the beginning of the year, its first quarterly decline since 2022, as Americans rushed to beat Trump’s tariffs, which sent imports surging. A higher trade deficit, a result of imports exceeding exports, subtracts from GDP.

Still, the US economy hasn’t fallen off a cliff just yet. In April, employers added a robust 177,000 jobs as the unemployment rate held steady at a low 4.2%, and even in the latest GDP report, a key gauge of underlying demand in the economy actually strengthened in the first quarter. Indeed, Powell sang the labor market’s praises.

That strength is allowing the Fed to remain on hold, since the economy doesn’t seem to need any support through rate cuts at the moment. Fed officials said in their statement that “economic activity has continued to expand at a solid pace,” in spite of the effects of surging imports on GDP.

But some economists doubt that economic resilience will persist indefinitely, with businesses struggling with the uncertainty sowed by Trump’s policies, according to various sentiment surveys. That lingering uncertainty could affect hiring plans, prompt consumers to pull back and eventually hamper business investment. Then of course, there’s also the direct effects of tariffs in pushing up prices, which would weigh on consumers who’ve already dealt with years of high inflation.

Overall, the economy isn’t currently sending a clear signal to the Fed on how it should proceed with borrowing costs. That’s precisely why Fed officials are standing pat at this meeting, but the most economists, in addition to the Fed now, agree there’s a real risk of stagflation.

Powell refused to directly answer questions related to Trump or his recent attacks.

Powell on the twin threat of stagflation

Stagflation bedeviled the Fed in the 1970s and early 1980s, and it may make a comeback because of Trump’s tariffs.

Powell again nodded to that possibility when taking questions from reporters, but how Fed officials ultimately react to the fallout of Trump’s tariffs will depend on a lot of factors and nuances, including whether or not any spike in inflation is temporary.

He laid out a simple playbook for how the Fed should address stagflation, should it occur outright: “We may find ourselves in the challenging scenario in which our dual mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal and the potentially different time horizons over which those respective gaps would be anticipated to close.”

The Fed may be forced to make the difficult choice of deciding which problem to address first, if push comes to shove. In the last episode of stagflation decades ago, the Fed with Paul Volcker at the helm chose to fight inflation, even if it meant the economy slipped into a prolonged recession. But it did the trick in vanquishing the entrenched inflation of that time.

When asked which side of its dual mandate the Fed would prioritize first, Powell said “it’s too early to know that.”

“Ultimately we think our policy rate is in a good place to stay as we await further clarity on tariffs and ultimately implications for the country,” he added.

And when asked how much of a weakening in the labor market would trigger a response from the Fed, Powell said “we would look at the whole huge array of labor market data to get a sense of whether conditions are really deteriorating or not, and at the same time, we’d be looking at the other side of the mandate.”

“Let’s say that unemployment is moving up in an uncomfortable way, and so is inflation — not the situation we’re in.” Powell said. “We would look at how far they are from the goals, how far they’re expected to be from the goals and what’s the expected time to get back to their goals.”

But some economists argue the Fed would be quicker to respond to any signs of a weakening job market, just as it did last year when it delivered a bold half-point cut after unemployment climbed steadily over a few months.

Powell said the tariff situation is constantly evolving, which means the Fed’s own view of the economy and its outlook could change along with it, especially if the Trump administration strikes any trade deals.

“We are entering a new phase where the administration is entering into beginning talks with a number of our important trading partners and that has the potential to change the (economic) picture materially or not,” he said.

Powell on the labor market’s resilience and America’s pessimism

Powell emphasized that the labor market remains solid, reassuring central bankers and allowing them to remain comfortably on hold for more data to trickle in.

“Conditions in the labor market are broadly in balance and consistent with maximum employment,” Powell said, adding that the steady job market isn’t putting any upward pressure on prices.

That’s true by many measures, such as continued robust job growth and unemployment remaining relatively low. New applications for unemployment benefits also remain low, though continuing claims — those who remain on unemployment rolls for multiple weeks — recently reached their highest level since 2021.

Still, consumer attitudes toward the economy have deteriorated in recent months amid the trade war, Powell noted.

He acknowledged America’s souring economic mood, but said that so far hasn’t manifested in the so-called hard data, economic figures that capture actual economic activity. The decline in GDP in the first quarter wasn’t driven by a sharp consumer pullback, though spending did slow somewhat.

Still, Powell admitted that persistent pessimism does pose a downside risk to the economy, but said “the timing, the scope, the scale and the persistence of those effects are very, very uncertain, so it’s not at all clear what the appropriate response for monetary policy is at this time.”

“It’s still a healthy economy, albeit one that is shrouded in some very down, deep sentiment on the part of people and businesses,” he said.

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