The Fed waits out the tariff economy

The Fed is trying to see how the dust will settle from the aftereffects of President Trump’s April 2 “Liberation Day" tariff announcements, among other policy changes. Most economists expect tariffs to lift prices over the coming months, and that is a worry for the Fed because officials still don’t feel as if they completely vanquished inflation after a three-year-long fight.

“We haven’t been through a situation like this, and I think we have to be humble about our ability to forecast it," Powell said.

Inflation has eased recently, but tariff effects loom. The job market shows hints of softness, though unemployment remains low at 4.2%.

“The data to date can be viewed as glass-half-full, or glass-half-empty," said Krishna Guha, vice chairman at Evercore ISI.

Powell offered nothing to hint at a July rate reduction, and investors eyed September as the earliest possible resumption of rate cuts paused earlier this year. With most relevant data still to come, it made little sense for the Fed chair to commit to a specific course of action, Guha said.

The timing for rate cuts “could come quickly. It could not come quickly," Powell said. “We feel like we’re going to learn a great deal more over the summer on tariffs."

If consumer prices shoot up this summer, the Fed will likely stay on the sidelines for longer. The labor market would have to convincingly sputter to prompt rate cuts.

But if a widely anticipated tariff-driven price punch turns out to be a damp squib, the Fed could be in position to consider cutting rates sooner, especially if the job market cools further.

Rate projections released Wednesday revealed a widening divergence among the 19 policymakers who gather roughly every six weeks to set rates. While 10 of them—a narrow majority—penciled in at least two rate cuts this year, the cohort of officials who think the Fed won’t cut at all this year saw its ranks rise, to seven from four in March.

Powell played down potential internal disagreements. “You can make a case for any of the rate paths that you see" in the latest projections, he said.

The divide suggests more officials won’t consider cuts without clear economic weakness. Fed officials don’t feel as if they can pre-empt any slowdown because that could make inflation worse, particularly after four years with inflation running above the central bank’s 2% target.

“We’ve just come through a generationally bad episode of inflation, and that undoubtedly has undermined confidence…that the Fed has the capability to control inflation on a precise basis over a near-term period of just a year or two," said David Wilcox, a former Fed economist now at Bloomberg Economics and the Peterson Institute for International Economics.

“That lack of confidence makes the inflation process more fragile so that it will take less in the way of a shock…to move actual inflation up," Wilcox said.

Powell has suggested that as the Fed studies more labor market and inflation data, the answer on whether to act or hang tight will grow more obvious. The Fed has a mandate to maintain low inflation and robust employment.

“It’s clear there are two segments within the Fed, and so far it’s not an open warfare between the two," said Michael de Pass, global head of rates trading at Citadel Securities. “If we do end up in a world where the tariff inflation feeds through at the same time that the labor market is softening, there’s much more tension at that stage."

The Fed leader defended the central bank’s wait-and-see posture at a news conference on Wednesday hours after a barrage of insults from Trump, who made new demands for the central bank to make the equivalent of anywhere from four to 10 rate cuts.

Trump argued that inflation has been tamed and that by keeping overnight rates around their current level of 4.3%, the Fed is needlessly inflating federal borrowing costs. “We have a stupid person, frankly, at the Fed," Trump said. “He’s costing the country a fortune."

Some investors warn that cutting rates aggressively without clear economic weakness could backfire by pushing long-term rates higher. Still, the Fed could be a useful foil for Trump, because if the economy weakens and the Fed subsequently cuts, he’ll claim vindication.

Powell’s let-the-data-speak posture helped underline the central bank’s independence from the White House, “particularly at a time when the institution is under attack, and he personally is under attack," de Pass said.

Powell spent much of his hourlong news conference reviewing all that the Fed doesn’t—yet—know.

Chief among those uncertainties is whether businesses will succeed in passing tariff increases along to customers or whether inflation-weary households and businesses will resist, leading to demand destruction.

“There are many parties in that chain. There’s the manufacturer, the exporter, the importer, the retailer and the consumer, and each one of those is going to be trying not to be the one to pay for the tariff," Powell said.

But someone will have to pay, Powell said—whether it’s just one party or all of them.

Write to Nick Timiraos at Nick.Timiraos@wsj.com