The Federal Reserve is in a tough spot following new data Wednesday reinforcing slower economic growth and higher inflation during the first quarter, a combination that may eventually force the central bank to choose between its dual goals of maximizing employment and maintaining price stability.
“It was still a stagflation warning shot over the bow of the economy,” Morgan Stanley Wealth Management chief economic strategist Ellen Zentner said. “This type of data won’t soothe the markets, and it won’t make the Fed’s job any easier.”
The US economy contracted for the first time in three years to start 2025 as a surge in imports dragged down GDP and prices increased more than forecast.
Luke Tilley, chief economist at Wilmington Trust, expects the US economy to slip into a recession in the second quarter with another contraction in growth.
“I don’t think that underlying demand looks all that solid,” Tilley said of the first quarter data. “Demand in the first quarter looks to be driven by businesses battening down the hatches before the storm.”
Read more: What is a recession, and how does it impact you?
Inflation during the first quarter also clocked in hotter than expected. The “core” Personal Consumption Expenditures (PCE) index, which excludes the volatile food and energy categories, grew by 3.5% in the first quarter.
That was above estimates for 3.2% and above the 2.6% seen in the prior quarter.
Inflation did cool, however, during the month of March as the quarter came to an end. That was before many of President Trump’s tariffs had been announced. Some economists expect those tariffs to push inflation higher.
“Core” PCE in March increased 2.6% year over year — a step down from 2.8% previously and in line with expectations. Month over month, the metric increased less than 0.1% from February.
Headline PCE increased 2.3%, while month-over-month PCE actually fell less than 0.1%.
‘Challenging scenario’
The economic data from the first quarter reinforces the “challenging scenario” for the months ahead, as outlined by Fed Chair Jerome Powell in a speech earlier this month.
Powell said on April 16 that the central bank may find itself between a rock and a hard place, where its dual mandate to keep inflation stable and employment high are at odds as the president’s tariffs push up prices while also lowering growth.
“We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension,” he said. “If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.”
President Trump continues to pressure Powell publicly to lower rates and did so again on Tuesday night at a rally in Michigan.
“I have a Fed person who is not really doing a good job,” Trump said.
Read more: How much control does the president have over the Fed and interest rates?
It was an apparent reference to Powell, although he didn’t mention Powell by name, with Trump saying, “I want to be very nice and respectful to the Fed.”
“You are not supposed to criticize the Fed; you are supposed to let him do his own thing, but I know much more than he does about interest rates, believe me,” he added.
Trump’s attacks on Powell ramped up after Powell’s April 16 speech, in which he also emphasized that without price stability, the Fed cannot achieve a strong job market for a long period.
Powell stressed that the Fed must keep inflation expectations well anchored and that the central bank needs to ensure that one-time price increases from tariffs do not turn into ongoing inflation. The White House wants the Fed to view any tariff inflation as transitory.
The Fed is not expected to change rates at its next meeting on May 6-7.
Read more: How the Fed rate decision affects your bank accounts, loans, credit cards, and investments
PNC Financial Services Group chief economist Gus Faucher said “maybe we could see” the Fed cut rates in the second half of 2025 if it sees weaker job reports.
“They want to see some sort of deterioration in the labor market before they cut again,” he told Yahoo Finance on Wednesday.
Investors will get a fresh reading on the job market on Friday. The April jobs report is expected to show that 133,000 nonfarm payroll jobs were added to the US economy this month while unemployment held steady at 4.2%, according to data from Bloomberg.
In March, the US economy added 228,000 jobs while the unemployment rate rose to 4.2%.
On Wednesday, data on private employers from ADP showed private payrolls grew by just 62,000 in April, far fewer than the 115,000 expected by economists and below the 147,000 new jobs added in March.
This marked the smallest increase in private payrolls since July 2024. Private employers added fewer jobs than expected in April as a sense of “unease” led to a slowdown in hiring and investors watched for signs that tariffs are weighing on economic growth.
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