Thanks To Trump's New Trade War, The Fed Might Have to Rescue the Economy...Again?

Trump's tariff has affected lots of things, and the market's expectation toward the Fed's next rate decision is one of them: traders now anticipating five additional rate cuts by the Federal Reserve this year.

Overnight activity in the interest rate swap market shows investors are betting on a 125-basis-point rate cut by year-end, equivalent to five standard 25-basis-point moves. Just last week, the market had only fully priced in three rate cuts.

Ask Aime: What is the market's expectation for the Fed's next rate decision and how does it relate to Trump's tariff impact?

This sharp adjustment reflects panic spreading across global markets. U.S. President Trump has shown no willingness to back down from the tough tariff policy announced last week, telling reporters on Sunday evening to "forget markets for a second."

Investors are frantically dumping risk assets and snapping up bonds, sending yields plunging. The yield on the policy-sensitive U.S. two-year Treasury note tumbled 22 basis points to 3.43% on Monday and has dropped about 50 basis points since Trump announced the tariff policy last Wednesday.

"There is no good news. The markets are getting ugly," said Michael Brown, senior research strategist at Pepperstone. "A policy pivot, from either the White House or the Fed, is what the market craves. Neither, for the time being, seems especially likely, leading to more economic, and market, pain being on the cards."

Goldman Sachs also noted in its latest report that the risk of the Fed further easing monetary policy will rise significantly if the U.S. economy falls into recession.

Under its current non-recession baseline scenario, goldman expects the Fed to begin a series of three 25-basis-point preventive rate cuts starting in June (previously July), lowering the federal funds rate to a range of 3.5%-3.75%. The report added, In a recession scenario, we expect the Fed to cut rates by about 200 basis points over the next year.

Goldman's current probability-weighted rate forecast also shows the Fed's cumulative rate cuts this year could reach 130 basis points (up from 105 basis points previously), reflecting a higher probability of recession. This revised expectation is now largely in line with the latest market pricing (five rate cuts this year).

But Does the Fed Want to "Rescue the market"?

Despite this, Fed Chair Jerome Powell appears to believe it is not yet time to step in to save the market, as he has emphasized multiple times that taking a wait-and-see approach seems a more appropriate method for him.

The latest data shows U.S. job growth remained strong in March. However, Powell cautiously noted that these figures were collected before Trump announced the tariff policy, so the best path for monetary policy is unclear at the moment, and the Fed needs to watch how things develop.

Acting swiftly and forcefully when the problem is clear has been the Fed's guiding principle, but in recent decisions, avoiding actions that may need to be reversed later has also been crucial. If Powell and other officials prematurely signal rate cuts while inflation remains high and may require maintaining elevated rates, it could trigger new economic threats.

Alan Blinder, former Fed vice chair, and Princeton economics professor, said Powell's "first job is to take out the view that the Fed is on the verge of slashing interest rates a lot in a hurry. That does not mean the Fed will never cut interest rates in response to this. If this develops into a recession, the Fed will probably cut."