It's hard to be the US Federal Reserve right now. The US economy contracted in the first quarter, and the White House ordered that the Fed lower its key rates as quickly as possible. At the same time, the Fed is dealing with great uncertainty about the future. Therefore, it is navigating by sight and faces difficult choices. Should we jump ship?
Towards a sustainably higher inflation?
It is difficult to predict the future of US monetary policy in the current situation. After agreeing to three key rate cuts in 2024, bringing its benchmark rate from the 5.25%-5.5% range to 4.25%-4.5%, the Federal Reserve seems determined to give itself time to observe the economy's evolution before announcing any new changes.
This caution is due, first of all, to the uncertainty regarding the evolution of inflation. At 2.4% in March, it was only slightly above its target of 2.0%. However, the core index, which excludes food and energy, is still at 2.8% after more than a year spent at more than 3.0%.
More importantly, the White House's imposition of tariffs is expected to increase the price of imported goods. A Fed study points to a scenario where a 20% tariff hike against China (and a Chinese retaliation) would result in 0.5% higher inflation and sustainably higher inflation. This would further move the Fed away from its objective, forcing it to remain cautious.
White House and markets hope for a decline.
While the Fed monitors inflation, the White House and, increasingly, investors are viewing the situation differently.
For the White House, which is worried about the economy contracting in the first quarter, cheaper credit is vital insofar as it would help stimulate domestic demand.
Faced with uncertainty about production and supply chains, companies no longer know how to go and are hesitant to invest. A strong demand would almost make you forget this. The share of private consumption in the US economy was approaching 69% at the end of 2024. If this demand is strong, companies will have no choice but to invest to meet it. A cheaper loan would therefore boost consumption and would also make investment less expensive, pushing the business world to take the plunge.
Cheaper credit would be welcome
Investors would also appreciate cheaper credit. To be sure, the American tech giants are, for the most part, huge profit-generating machines. However, the innovation that the country needs to maintain its technological leadership in areas of the future, such as artificial intelligence, also involves companies with very significant capital needs.
The less expensive this financing is, the more these sectors will be able to grow. It is, therefore, no coincidence that the Nasdaq – and the US stock market as a whole – welcome every rate cut. This phenomenon is further reinforced by the fact that the decline in the yields offered by bonds is reducing the attractiveness of these investments, which have recently been competing with stock market investments.
Bad news, good news?
While the views of the US central bank on the one hand and the White House and investors on the other seem irreconcilable at this stage, it would not take much for everyone to agree.
At this stage, the labour market remains the cornerstone of the economy. Victim of the surge in imports before the entry into force of customs duties, it took a nosedive in the 1st quarter. Other indicators point to a loss of confidence among households and businesses and a general slowdown in activity, with PMI figures for business activity barely positive. However, the unemployment rate remained at 4.2% in April, with 177,000 jobs still created, work-related incomes increasing faster than inflation, and purchasing power still rising.
A sudden deterioration in these employment indicators would change the situation. Coupled with a slump in the economy, it would push the Fed to intervene, lowering its key rates and thus adopting the long-awaited monetary policy easing.
This scenario is not impossible at this stage: the slowdown in economic activity is a reality, and the chances of a recession in the United States have risen sharply. By his actions, Donald Trump could well force the Fed to approve the outcome he wants. The markets would not fail to celebrate.
Stagflation: the worst-case scenario
The only grey area in this picture is inflation and the possibility of stagflation. The White House continues to defend the hypothesis that the prices of imported products will not move because those who export to the United States will lower their starting prices, reducing their margins to preserve their market share. The tariffs would, therefore, not cost the American consumer much.
This is an optimistic hypothesis, to say the least, insofar as some players – particularly China – do not seem to want to play the game, let alone reduce their margins.
Inflation is, therefore, likely to be part of the game. Coupled with a sharp economic slowdown, this would place the United States in stagflation: an economy that is struggling, coupled with inflation that is too high, which would prevent the Fed from acting on key rates. Of course, after years of quantitative easing, the Fed's toolbox is well stocked, and it is a safe bet that it will find other ways to support the economy as best it can. However, such a scenario would never be comfortable for the Fed or Washington, and the slump could last for a long time.
Do not miss the rebound
With uncertainty at an all-time high, the Fed will have a hard time navigating its way in the near future. Already in contraction, the US economy is clearly at risk of a recession, and if inflation picks up again, the Fed's room for manoeuvre to intervene will be reduced.
Does this mean that we should turn away from American assets? We do not think so. The rest of the world catches cold when the United States catches cold.
Any US recession will affect the entire global economy, even with global trade slowing. At a time when European and Asian demand (China, Japan, Korea) are weak, the American market is taking on exceptional importance. If it slows down, the global economy will be impacted.
Then, as usual, the US economy will be the first to rebound. It is competitive, highly flexible, and demonstrates an enormous capacity for innovation and adaptation; it will regain its energy before the others. Moving away from the US market today could lead to missing this rebound, which could be violent if Donald Trump adopts more pragmatic positions or the Fed starts to lower rates.
Therefore, we remain invested in the bond and equity markets in the United States.
The FED's Main Policy Rate
After three cuts in key rates in 2024, the Fed is sailing by sight in 2025, even as the chances of a recession increase. This does not reassure investors.
See our current portfolio recommendation:
