Capital Markets | Tariff Update May 2025

Monetary Policy Update

May 7, 2025

As expected, during its May meeting, the Federal Reserve voted unanimously to leave the fed funds target rate unchanged at 4.25%-4.50%. In its press release, the Fed acknowledged that despite “uncertainty about the economic outlook” and that “risks of higher unemployment and higher inflation” have risen, economic activity was still expanding at a “solid” pace. In other words, while the sentiment and concern are very real, the Fed has yet to see any economic data that would justify monetary policy accommodation (i.e. rate cuts) at this point. It is important to note that the full impact of tariffs that were implemented on April 2 will not be known until more information about consumer spending and business investment becomes available in the weeks, and possibly months, ahead. Powell did note that the unusual import swing during the first quarter (from front-running tariffs) complicated the recent GDP data.

Markets currently expect the Fed to cut its short-term policy rate by a total of 75bps before year end. This would leave the Fed’s short-term policy rate at 3.50-3.75% by the end of 2025. The Fed’s “dot plot” currently suggests that short-term rates may only be cut by 50bps before year end.

Why did the Fed decide to keep its short-term policy rate unchanged?

As a refresher, the Fed’s dual mandate outlines two main goals of the Fed’s monetary policy: price stability and maximum employment. Its actions, primarily through interest rate decisions, aim to influence the economy to achieve these two objectives. As of the latest meeting, there is little evidence of tariffs weighing on the economy — recent job reports remain strong and inflation has remained in check. If the announced tariffs are sustained, however, they will likely result in a rise in inflation, a slowdown in economic growth and an increase in unemployment. Powell cited that while progress has been made on inflation, it is still running above the 2% target and avoiding persistent inflation will depend on the size and lasting power of the tariffs.

This poses a dilemma for the Fed. It must determine whether to focus more on the risk of higher inflation or the risk of rising unemployment and, in turn, balance the risks and potential benefits of policy decisions. Should the Fed choose to lower interest rates to support growth and employment, it risks higher inflation. Alternatively, raising rates in hopes of keeping inflation in check risks higher unemployment (not to mention, a host of credibility issues if the Fed reverses its path of lowering rates started last year). It seems the best strategy is to choose the option — out of a list of options none of which are ideal — of waiting for data to provide more clarity before making any policy adjustments.

How did markets respond to the Fed’s decision?

While this was the first FOMC meeting following the tariff announcements, it was largely anticipated that the Fed would hold rates steady. At this point, the Fed has been very clear of its data dependence while assuring markets it remains flexible amid tariff uncertainty. Comments following the decision were largely innocuous. Market reaction to the Fed’s announcement was rather muted. Equity markets dipped on the initial news but recovered declines, finishing the day up only slightly at +.4%. Treasury yields too, fell initially after the Fed’s decision but recovered some of that initial selloff as the Chairman delivered post-meeting remarks.

What is new with tariff negotiations?

Much relies on continued progress of trade deals. While some appear imminent with certain countries, deals with crucial trade partners have seemingly made little to no progress. The market reacted positively today to the first announced trade deal, between the US and UK. Although the final details are said to be available in the coming weeks, initial indications are that the US will lower tariffs on UK-made cars to 10% in exchange for lower tariffs on American food and agricultural products sent to the UK. Markets will continue to react to news headlines until any real clarity is made around where tariff rates settle and how their impacts flow through to economic data points via inflation, real income and investment levels. It is possible we may not see the impacts flow through for a few more months, at least. In short, a lot of uncertainty remains. We will continue to provide updates in the weeks ahead as facts and circumstances change.

Weekly Market Update

May 2, 2025

What happened in markets this week?

Market volatility in both equity and bond markets remains largely unchanged for the week, and while it is still elevated, it has subsided from its peak levels in early April. On Wednesday morning, it was reported that GDP contracted by 0.3% in the first quarter, the first negative quarter since 2022. The stock market opened broadly lower, as the initial reaction aroused recession fears, but as investors dove into the details, it became clear that the spike in imports from companies attempting to build inventory and front run the tariffs during the quarter was the predominant reason for the negative reading. The market rallied back late in the day and the S&P 500 finished green for the seventh consecutive day. On Thursday, the market continued to push higher on the back of resilient earnings reports.

For the week thus far, the S&P 500 is up 1.4% and bond yields have oscillated within a fairly tight range as the 10-year Treasury yield sits at 4.2%. For the month of April, the S&P 500 finished down 0.7% — a fairly unremarkable monthly return considering equity markets were down more than 10% intra-month.

What to expect with tariffs in the future?

Some relief may be coming, but uncertainty will continue to linger. Goods-specific tariff exemptions will continue to be announced, but the magnitude of this relief and industries impacted remains unclear. This week, the US announced temporary relief on auto tariffs, which would allow reimbursements for domestic car producers importing car parts as well as shield manufacturers from “stacking” tariffs.

Additionally, while trade deals with selected US trade partners are likely to be announced soon, the scope of these deals and the countries involved are currently unknown. Recent reports have hinted that the first trade deal has been reached, but no further details were shared. All indications point to imminent deals with India and Japan.

Negotiations between China and the US are likely going to be challenging. Even though both countries have expressed a willingness to negotiate, there is a low probability of any meaningful trade concessions occurring in short order, as neither country seems to be certain where talks currently stand. While Treasury Secretary Bessent has stated that he anticipates de-escalation with China, Trump continues to stress that it will need to reduce tariffs significantly.

Talks with the EU have remained rocky, as little advancement has been made on that front. However, many countries appear eager to negotiate and the market continues to respond favorably to the prospect of trade deals. The possibility also remains that the 90-day pause on tariffs could be extended if progress continues to be made.

Is the contraction in GDP in Q1 a sign that the US is moving into a recession?

Despite the 0.3% decline in GDP in Q1, overall economic activity in the US was not all that "bad" actually. When breaking down the components of GDP, it can be seen that consumer spending grew by about 2% and business investment increased by about 10% in the first quarter. The decline in overall GDP in Q1 can almost entirely be attributed to companies “front running" tariffs (which resulted in a very high level of “net exports” in Q1). In fact, if net exports were stripped out of the GDP calculation, GDP would have grown at about 3% in Q1. This large net export imbalance is not expected to be a drag on GDP in the coming quarter(s), as the ability to get ahead of any tariffs is now very limited.

All of that being said, the GDP data released this week is based on economic activity that occurred prior to the announcement of tariffs in early April, so it remains to be seen exactly how the economy will adjust going forward. Currently, Q2 GDP is expected to rebound to about 2% (on an annualized basis), but nobody can predict just how consumers and businesses will respond to tariffs or what the tariffs will even be at this point. Should consumer spending decline significantly in the months ahead, markets would begin to price in a higher probability of economic recession.

Additionally, it is important to reiterate that the Federal Reserve is in no hurry to reduce its short-term policy rate. The Fed has continued to communicate that it will not consider rate cuts until inflation moves closer to the Fed’s inflation target of 2%. And since tariffs are likely to push aggregate inflation at least a little bit higher over the short term, it appears that the earliest the Fed might cut rates again would be in the second half of 2025 (absent a material increase in unemployment).

We will continue to provide updates in the weeks ahead as facts and circumstances change.