The Fed’s Dilemma — Evening Brief – 05.21.25 

As the U.S. economy teeters between stubborn inflation and weakening growth, the Federal Reserve is confronting one of its most complex policy dilemmas in recent memory. Chair Jerome Powell has acknowledged that addressing inflation and sluggish output demands “fundamentally different responses,” highlighting the challenge of navigating an environment increasingly marked by stagflationary dynamics. 

While Powell has downplayed the long-term inflationary impact of tariffs—referencing the relatively muted effects during the first Trump administration—the current wave of 2025 tariffs appears broader, deeper, and more durable. This time, trade actions are accompanied by tighter immigration policies that could further strain labor markets. With fewer workers in key sectors, structural inflationary pressures may build, even if tariffs eventually ease—an underappreciated risk in Powell’s recent commentary. 

Evidence of rising inflation expectations is mounting. The University of Michigan’s May 2025 Survey of Consumers pegged one-year inflation expectations at 7.3%, up sharply from 6.5% the prior month and the highest level since 1981. Longer-term five-year expectations have also climbed to 4.6%—a troubling sign that inflation may be becoming entrenched in public psychology. While the New York Fed’s survey paints a more mixed picture, the growing divergence raises questions about whether inflation expectations remain “well-anchored.” 

At the same time, growth risks are intensifying. The combination of tariffs, anticipated federal spending cuts under the DOGE framework, and other policy headwinds are poised to drag on economic activity. Though these effects are not yet fully visible in hard data, sentiment and forward-looking indicators are flashing caution. 

Despite mounting pressure, a Fed pivot to rate cuts is unlikely before July. The CME FedWatch Tool now assigns only a 5% probability to a June rate cut—down from 55% just two weeks ago. September has emerged as the more likely target, with odds at 54%. Even dovish voices within the Fed are urging patience. “It’s not going to be that in June we’re going to understand what’s happening here, or in July,” said New York Fed President John Williams on May 19. “It’s going to be a process of collecting data, getting a better picture, and watching things as they develop.” 

Atlanta Fed President Raphael Bostic echoed this cautious stance, forecasting just one rate cut in 2025, depending heavily on tariff developments. He noted that if trade negotiations progress and tariffs are rolled back, the Fed “may be able to pull forward some actions,” potentially easing monetary conditions earlier than currently expected. 

Yet for now, the Fed remains sidelined by fiscal and trade policy uncertainty. Markets are less responsive to rate speculation and more attuned to the evolving stance of the administration on tariffs and labor. As Powell and his colleagues wait for greater clarity, the clock is ticking. Should inflation expectations continue to rise alongside a slowdown in output, the Fed may be forced into a high-stakes balancing act—one where the usual tools may prove insufficient.