Fed Holds Steady as Trade Tensions Cloud Inflation Outlook

Despite a recent stretch of muted inflation data, policymakers remain cautious, waiting to assess the full impact of recent tariff hikes and ongoing global trade tensions. The reasoning is strategic: inflationary pressures from tariffs may still emerge, and until trade agreements are finalized, the economic environment remains too uncertain for the Fed to confidently pivot to a looser monetary stance.

May’s consumer price index (CPI) rose just 0.1%, with the core CPI—excluding food and energy—also increasing by a minimal 0.1%. Year-over-year inflation is currently running at 2.4%, with core inflation at 2.8%. These readings came in below expectations, adding fuel to calls for rate cuts. However, the Fed has signaled it will remain patient. Forecasts now point to the first possible rate cut occurring in September, depending on how the next round of trade negotiations evolves.

The delay is rooted in concerns about tariff-induced cost pass-through. Trade tensions, particularly the U.S.-China standoff and broader “reciprocal tariff” policies pushed by President Trump, are reshaping import dynamics. Although recent inflation data has not shown a sharp uptick, economists warn that this could be temporary. As inventories stockpiled ahead of tariff announcements deplete, cost increases may gradually work their way into consumer prices.

The key issue is the elasticity of demand across different product categories. Products with inelastic demand—like certain foods or household essentials—may see importers pass on nearly all tariff costs to consumers. In contrast, goods with more elastic demand, such as apparel or electronics, may see importers and retailers absorb more of the burden to maintain market share. This selective pass-through is already visible in May’s data, where prices for canned goods and appliances rose while vehicles and clothing fell.

For products with high demand elasticity, however, the burden of tariffs is likely to fall on American consumers, not foreign producers. Importers will internalize as little of the cost as possible, protecting margins by raising prices when feasible. The result could be billions of dollars in added costs to U.S. households if trade tensions persist.

The Fed, the Trump administration, and U.S. trading partners are now engaged in what economists describe as a sequential signaling game. Each party is acting with asymmetric information and strategic uncertainty. The Fed is signaling a “wait and see” approach, hoping inflation expectations remain anchored. Meanwhile, the administration is using tariffs as leverage in negotiations, insisting that the costs will be absorbed abroad—a claim many economists dispute.

Foreign governments, facing unclear U.S. intentions and domestic pressures of their own, are hedging in negotiations, adding further volatility. The Beige Book confirms that businesses across Fed districts are already bracing for higher input costs, even as they hesitate to raise prices amid soft consumer demand.

The charts reinforce the broader narrative. The CPI’s month-over-month gains have moderated considerably since mid-2022, but volatility remains. Similarly, the Federal Funds Effective Rate has plateaued around 5.25% since early 2023. While forecasts show a potential dip in rates starting in September, that outlook depends on a delicate balance of inflation trends, consumer behavior, and geopolitical outcomes.

Until there is greater clarity on the trajectory of trade deals, especially with major partners like China, the Fed is unlikely to shift policy. Any sign of entrenched inflation—even if driven by a narrow set of tariff-sensitive goods—could delay rate cuts further.

In short, the Fed’s caution reflects not just the data, but the uncertainty behind it. With inflation soft but fragile, and trade talks unpredictable, monetary easing must wait.

Sources & References

Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [DFF], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DFF, June 16, 2025.

CNBC. (2025). U.S. inflation rises 0.1% in May from prior month, less than expected. https://www.cnbc.com/2025/06/11/cpi-inflation-may-2025.html 

CNBC. (2025). Fed ‘Beige Book’ economic report cites declining growth, rising prices and slow hiring. https://www.cnbc.com/2025/06/04/fed-beige-book-economic-report-cites-declining-growth-rising-prices-and-slow-hiring.html 

CNBC. (2025). Here are the three reasons why tariffs have yet to drive inflation higher. https://www.cnbc.com/2025/06/12/here-are-the-three-reasons-why-tariffs-have-yet-to-drive-inflation-higher.html 

US Bureau of Labor Statistics. (2025). CPI. https://www.bls.gov/cpi/