Employment inflation double report set the fate! The Fed's interest rate cut path faces Trump's tariff test.

Although the economic community generally expected President Trump's tariff policy to significantly raise inflation in the coming months, the mild price increases so far have cast doubt on this consensus. This trend has both boosted the confidence of the White House and exacerbated policy divisions within the Federal Reserve. Due to expectations of strong inflation, the Federal Reserve has maintained interest rates unchanged this year. The Trump administration is exerting significant pressure on Fed Chairman Powell to cut rates, and recently two Fed officials have publicly disagreed with Powell, advocating for rate cuts to begin in July. Two key data releases in the next two weeks - the nonfarm payroll report on July 3rd and the Consumer Price Index on July 15th - will be crucial factors in the Fed's decision-making. While these two data are expected to show the impact of tariffs for the first time, any unexpected results could change the timeline for rate cuts. "The current situation is so tricky, in part because we have never conducted this kind of policy experiment before," said William English, a professor at Yale School of Management and former senior economist at the Fed, when discussing tariffs. "This is beyond the experience of the modern U.S. economy, so any predictions are difficult to guarantee accuracy." Recent data shows that despite the continued implementation of tariff policies, inflation remained mild in May, prompting Trump and his allies to increase criticism of the Fed. The US President has repeatedly insulted Powell as a "knucklehead" and called him "one of the most stupid and destructive people in government." Several senior government officials, including White House National Economic Council Director Kevin Hassett, as well as usually silent Republican lawmakers, have also joined in the criticism. Hassett declared on June 23 that "there is no reason for the Fed not to cut rates immediately." Hassett is considered a possible successor to Powell after his term ends next year. He emphasized the data that will be released in the coming weeks: "I guess that if they see the data for another month, they will have to admit that current interest rates are too high." This debate reflects the policy dilemma facing the Fed: if they hastily cut rates amid tariff-induced price pressures, they may be forced to take more aggressive measures in the future; but if they maintain high rates to address potentially unfounded inflation expectations, they may unnecessarily suppress the economy, even harming the labor market. Forecasters expect inflation to accelerate in the coming months. Powell testified before Congress last week that as tariff impacts permeate the economy, significant price hikes are expected in June, July, and August. However, he added that Fed officials "fully acknowledge" the possibility that tariffs may have a smaller impact than expected, which "will affect our policies if true." The US Bureau of Labor Statistics will release the June Consumer Price Report on July 15, two weeks before the next Fed policy meeting. Fed governors Waller and Bowman (both appointed by Trump) have diverged from Powell and their colleagues, suggesting that a rate cut may be possible next month if the data supports it. Waller said in an interview on June 20, "I believe we have room to cut rates and can observe inflation trends afterward." He also added that if necessary, the central bank can pause rate cuts at any time. "We have paused rate cuts for six months to wait and see, and the current data is performing well." Nonetheless, according to the federal funds rate futures, investors currently estimate the probability of a rate cut in July to be only about 20%, instead betting on a rate cut in September. The Math of Tariffs Mild inflation data as of May suggests that despite Trump imposing tariffs on dozens of US trading partners, and with widespread uncertainty still surrounding the duration and final tax rates, businesses are currently trying to avoid price increases. Josh Hirt, senior US economist at Vanguard Group, suggests that one possible explanation is that businesses are digesting import inventories accumulated in the first quarter to avoid tariffs. Hirt's calculations show that the actual tariff rate paid by importers this year is lower on average than Trump's nominal tariff rate, mainly because a large number of goods were imported before the tariffs took effect. Another major uncertainty mentioned by Powell in his testimony is how the cost of tariffs will be shared among exporters, importers, retailers, manufacturers, and consumers. Powell said, "Initially, importers will pay tariffs, but the ultimate cost will be shared among these five entities." He added that data shows at least some of the impact will be passed on to consumers. Economists Estelle Ou and Andrej Sokol of Bloomberg Economics stated, "After a brief drop in April and early May, container shipping from China to the US rose again, with imports at least expected to surpass normal levels by the end of the summer. If this trend continues, US stores will be well stocked before the holiday season, which may mean that businesses do not have to rush to pass on the cost of tariffs this year." Prior to the inflation report on July 15, the Bureau of Labor Statistics will release equally important monthly employment data on July 3. To date, there is little evidence of tariffs impacting the labor market, which allows Powell and most of his colleagues to maintain their stance: a robust labor market means there is no rush to cut rates. However, similar to inflation data, forecasters generally believe that the potential impact of trade policy turmoil on the labor market will not be evident until the release of June data. A survey shows that economists expect the report to be released this week to show a slight increase in the unemployment rate to 4.3%, the highest level since 2021. In a speech on June 23, Bowman said that Fed officials should "recognize that given recent signs of weakening consumption and labor market fragility, the downside risks to employment targets may escalate quickly." Monthly consumption data released by the US Bureau of Economic Analysis last Friday showed a decrease in household spending in May, as consumers cut back on non-essential services such as travel and dining. Forecasters warn that rising prices in the coming months will further squeeze consumption. English from Yale School of Management said that the impact of tariffs will depend on many difficult to quantify factors. However, "the intuition that part of the tariff cost will eventually be passed on to prices seems reasonable. I still believe that the basic logic is not wrong."