Trade uncertainty: US trade policy can complicate the Fed's choices

It has been more than two months since Donald Trump became President of the United States (US), and yet both US citizens and stakeholders around the world are still trying to understand the implications of his policies. The first economic projections by the US Federal Reserve since Mr Trump took office also reflected this. In terms of hard numbers, projections by the members of the Federal Open Market Committee (FOMC) suggest that, compared to the previous projections, they expect the inflation rate to firm up, economic growth to slow, and unemployment to increase this year. While the magnitude of change is not very dramatic, the direction does reflect the impending uncertainty. The only positive bit from the financial-market standpoint is that the FOMC is still on course to deliver rate cuts — of 50 basis points — in 2025. 

Nevertheless, Federal Reserve Chairman Jerome Powell noted in a post-policy news conference that owing to tariffs progress might be further delayed on getting back the inflation rate to the medium-term target of 2 per cent. He also acknowledged that uncertainty was remarkably high. While the Fed has retained its policy interest-rate projections, it seems willing to wait and see how Mr Trump’s policies affect economic outcomes. There are several sources of uncertainty, but at the top of the list is trade.  While the US has imposed tariffs selectively as of now, including specifically on China, its plan to impose reciprocal tariffs on April 2 is likely to significantly disrupt global trade.

  Such disruption would complicate policy choices for the Fed. The conventional policy understanding suggests that monetary policy should look through such one-time shocks. However, things may not be that simple this time around. The inflation rate in the US is above the target of 2 per cent and another price shock could affect expectations. It is worth noting that the Fed misread the post-pandemic surge in prices, and its commentary will now be viewed against that background. Further, while tariffs could affect prices and inflation expectations, the associated uncertainty is affecting business confidence — partly reflected in the Fed’s projection of slower growth and higher inflation. 

However, Mr Trump’s disruptive ideas are not just about tariffs. The administration’s policies on immigration, for instance, will have longer-term consequences for the US economy. Unsurprisingly, the initial market enthusiasm for Mr Trump’s policies — many expected it to provide a short-term economic boost, at least — has faded, as reflected in the stock market decline. The S&P 500 has lost about 8 per cent from recent highs. The dollar index has also declined over 5 per cent since mid-January. The decline has benefited other markets — the Indian benchmark stock market indices, for instance, went up by over 4 per cent last week.  Nonetheless, investors and policymakers in India need to prepare for uncertainty, at least in the near term. It is not clear how reciprocal tariffs will be implemented. It would be a bureaucratic nightmare even for the US. Besides, India will need to continuously engage with the US administration. A team of US trade officials will be in India this week to take the proposed bilateral trade agreement forward. Developments on this front will be keenly followed. While the Trump presidency is likely to remain disruptive, some clarity should emerge once trade-related uncertainties are addressed.