Trump Cannot Scapegoat - or Fire - Powell for Trumpflation
In 100 days, Trump neutered the Fed’s primary monetary tool to deal with his turbulent economy
In our tariff roundup post, we discussed the role of the Federal Reserve and the Federal Open Markets Committee (FOMC) in making monetary policy. Today, the FOMC will meet for its third of eight annual meetings. They are not expected to lower interest rates—principally because actions taken by the President of the United States have hamstrung the Fed’s ability to deal with his turbulent economy. Senate Banking Committee Ranking Member Warren recently underscored how Trump’s policies are squeezing the Fed from both sides:
“In just 100 days, President Trump has managed to hamstring the Fed’s primary monetary tool to deal with a turbulent economy. If he refuses to reverse course on his disastrous economic policies, the Fed will be forced to either keep rates higher longer or scramble to respond to a weakening economy. The President can blame his predecessor or Fed Chair Powell all he wants, but the inescapable fact is that prices are rising and our economy is headed toward recession because of Donald Trump.” – Senator Warren
The Federal Reserve has three mandates set out by Congress to promote a healthy economy—stable prices, maximum employment, and moderate long-term interest rates to support stable long-term economic growth. Its primary monetary tool for executing its congressional mandate is adjusting the federal funds rate, a key benchmark that drives interest rates for lending across the economy. Lower rates stimulate economic growth and job creation but risk increasing inflation. Higher rates help control inflation but can slow growth and increase unemployment. Usually the Fed can balance these competing pressures. But as Donald Trump’s policies incite worries about stagflation (i.e., slower growth occurring at the same time as rising prices), it’s not clear how the Fed can use monetary policy to respond effectively.
Let’s dive deeper into how the Fed is constrained in fulfilling its mission, a little over 100 days into Trump’s second term.
Stable Prices
The Fed’s stable prices mandate directs it to keep inflation down. Unfortunately, the inflation outlook has darkened since January.
Recent survey data shows consumers bracing for higher prices. Year-ahead consumer inflation expectations jumped to more than 9% after Trump’s April 2nd tariff announcement—the highest since 1981. Estimates declined after Trump announced a 90-day pause on some of the tariffs, but inflation expectations remain well above levels 100+ days ago, when they were 3.3%. While changes in inflation expectations don’t necessarily materialize one-to-one in actual changes to inflation, expectations impact economic behavior and the Fed’s effectiveness. As consumer inflation expectations move further from the Fed’s target inflation rate (i.e., become “unanchored”), consumers grow more sensitive to price changes. This ties the Fed's hands—they can't cut rates as deeply during recessions or fight supply shocks as effectively.
Source: University of Michigan, Surveys of Consumers
And it’s not just consumers who see inflation rising. During the March FOMC, all participants reported increased inflation expectations from December, with most estimating that 2025 inflation will land in the 2.7-2.8% range.
Source: Federal Reserve Board, March 2025 Summary of Economic Projections
Finally, we’re starting to see these elevated expectations materialize in the data. While March’s Personal Consumption Expenditures (PCE) inflation index was flat month-over-month, the annualized Q1 inflation rate increased to 3.6% from 2.4% in Q4 2024. And it’s not a coincidence—Trump’s policies are directly contributing to higher inflation. By one estimate, his tariffs could increase PCE by 2.97% this year alone.
The bottom line on prices is that Trump’s policies are keeping inflation above the Fed’s target—and will likely drive it even higher. In a vacuum, the Fed would respond by holding rates steady or raising already restrictive rates. But they also have to care about the labor market.
Maximum Employment
The labor market outlook has also become more precarious since January.
Last week’s BLS jobs report showed a labor market that remains somewhat stable—but the administration’s unpredictable trade policies have created significant uncertainty for businesses, making them hesitant to invest or expand. Economists and business executives alike believe this situation represents an immediate threat to employment stability.
Multiple sectors are signaling potential layoffs ahead as businesses worry about higher input costs from tariffs and anticipate reduced consumer spending. CEOs are going on record saying they’re now less likely to grow their workforces over the next six months. And we’re already seeing cuts in the manufacturing sector. In March, manufacturing payrolls fell by 1,000 in and average weekly hours in the manufacturing sector fell by 0.2. The Institute for Supply Management’s monthly manufacturing index shows new orders, production, and employment all declining, suggesting that further slowdowns and layoffs are on the horizon.
Additionally, the labor market may be less robust than implied by last week’s report. Through the first quarter of 2025, the 3-month moving average for total nonfarm payroll growth has declined—only exacerbated by consistent downward revisions month after month. If April follows the same pattern, and last week’s data is revised down, the 3-month average job growth will remain relatively flat between March and April and, overall—below where we began the year.
Source: FRED, Committee Staff calculations
Note: Light blue represents the April forecast, which we used to calculate a hypothetical 3-month moving average should today’s number be revised down closer to expectations.
There are additional warning signs as well. Last week, private payroll growth came in well below expectations, weakening to its lowest point in 9 months. Initial jobless claims ticked up, and continuing claims jumped to its highest level since the end of 2021—meaning that people who are unemployed are staying unemployed for longer. And this is compounded by declines in job openings, which are down by more than 900,000 over the year.
The bottom line on employment is that while the labor market is slowly cooling and unemployment is holding steady, Trump’s policies are likely to lead to layoffs. And in a labor market where job openings are declining and continuing claims are skyrocketing, that will cause rising unemployment that is difficult to bring down—especially once it begins in earnest. This situation calls for the Fed to cut rates—but as noted above, that would have the opposite effect on prices, so the Fed is stuck.
Moderate Long-Term Interest Rates
What about the Fed’s third mandate?
The goal of a stable long-term environment for business investment is achieved by creating economic conditions where rates like 10-year Treasury yields remain at sustainable, balanced levels. This helps provide stability to the financial system, prevents market distortions, and supports sustainable government borrowing. It's largely achieved as a byproduct of successful inflation management, as well-anchored inflation expectations lead to more stable long-term interest rates—though the Fed has some reactive tools they can deploy as a last resort.
Unfortunately, things are looking bleak in this department as well. As we discussed in our tariff roundup,10-year Treasury yields spiked as the markets cratered after Trump’s April 2nd tariff announcement. While they’ve modestly declined, they remain elevated compared to pre-announcement levels, signaling that investors see greater risk in treasury securities, which are supposed to be a “safe-haven”—along with additional inflation risks.
At the same time, credit spreads, which reflect the difference in a corporate bond yield and a Treasury bond yield of the same maturity, have widened since Trump took office (see graph below). This means that investors are demanding a higher premium due to market stress, economic uncertainty, and a lower appetite for risk-taking. So, as investors price in escalating risks in government-backed securities (alongside inflation fears), they’re signaling even more pronounced vulnerabilities in private markets.
Source: Bloomberg
These trends indicate tightening across financial markets independent of the Fed—effectively limiting the institution’s available policy options. If long-term rates continue to rise for reasons independent of monetary policy, the Fed’s ability to act will be blunted.
If, as expected, the Fed holds rates constant, it will reflect the difficulty faced by the central bank in acting to address deteriorating conditions in our economy. The Fed must thread the needle between fighting tariff-induced inflation and supporting an employment market that shows concerning signs of weakness. But with Trump’s economic policies pushing up prices, threatening employment, and tightening the conditions for private investment, the Fed can’t use interest rates to address one problem without exacerbating the others. Unless the President reverses course, American consumers and businesses are likely to face continued uncertainty, higher costs, and potentially slower growth as 2025 progresses.