Federal Reserve officials meet on Tuesday, and the latest economic data may further reinforce their concerns that the Trump administration's policies, or at least the intense uncertainty surrounding them, will drag on economic growth in the coming months.



Shortly before the start of its two-day policy meeting, the Commerce Department reported that U.S. retail sales fell 0.9% in May, more than the 0.7% drop expected by economists in a Reuters poll and the biggest drop in four months. The central bank's own report then showed industrial production unexpectedly contracted last month.

However, the direction of these data is not entirely clear.

The retail sales report, which was revised to show a small decline in April as well, was largely weighed down by slowing auto sales, which had surged earlier in the year as consumers sought to avoid a 25% tariff on imported vehicles. Bradley Saunders, North American economist at Capital Economics, said bad weather was also likely a factor, while underlying goods sales data, which are more closely tied to broader economic conditions, suggested that “consumption overall still appears healthy.”

However, a 0.2% drop in industrial production pushed down the overall capacity utilization rate to 77.4%, the lowest level since January.

Another survey showed homebuilder confidence slipped to its lowest level in 2-1/2 years due to weak demand from buyers and high financing costs. This factor has to do with monetary policy and the Federal Reserve's reluctance to cut interest rates further until it is clear that President Donald Trump's tariff policies will not lead to persistent inflation.

Despite rising tariffs, recent inflation data has remained tame. However, the Fed is still working to reduce price increases to 2% after years of surging inflation in the wake of the COVID-19 pandemic, and tariff-driven price increases are still seen as "on the way."

The risk of rising prices remains a major concern for the Fed, despite signs that the overall economy may be slowing. Trump’s final tariff plans remain unclear: He has promised trade deals, but agreements with dozens of countries threatened with tariffs remain unfinished, and one-off proposals to tax specific goods such as appliances may or may not be implemented.

Meanwhile, ongoing hostilities between Iran and Israel have pushed up oil prices, another risk the Federal Reserve must contend with as it prepares to release a new policy statement on Wednesday and update policymakers’ economic and interest rate forecasts.

James Knightley, chief international economist at ING, noted that the retail sales data is not adjusted for inflation, and after accounting for price increases, the decline "paints a weak picture that reflects subdued consumer confidence readings. Households are concerned that tariff-induced price increases will squeeze spending power, while respondents have grown more cautious about the job outlook, suggesting that consumer spending will continue to cool this year."

How to balance the risks of slower growth against expected higher inflation will be at the heart of the debate among Fed policymakers on Tuesday and Wednesday, when they are also likely to discuss the impact of the Middle East crisis.

Fed forecast

The U.S. central bank is widely expected to keep its benchmark interest rate in a range of 4.25% to 4.50% where it has been since December and reiterate that it can’t offer much guidance until it’s clearer whether Trump’s import tariffs and fiscal policies are pushing up inflation and weakening growth, or, as his administration claims, keeping growth on track while prices fall. Trump has called for an immediate rate cut.

However, days of intense missile exchanges between Israel and Iran gave the Federal Reserve more reason to remain cautious after oil prices surged again on Tuesday, which could also become a new source of inflation.

The clash highlights the uncertainty that Fed officials say has dominated their policy debate since Trump returned to power in January and launched more aggressive than expected moves to raise import taxes and rewrite global trade rules.

Fed officials and many economists widely expect Trump’s trade policies to have a stagflationary effect on the U.S. economy, slowing growth and pushing up prices. The path of monetary policy — whether to cut interest rates or keep borrowing costs at current levels for a long time — will depend on which problem appears to be more serious.

The Federal Reserve will release a new policy statement and updated economic and benchmark interest rate forecasts at 2 p.m. ET on Wednesday (02:00 BJT), with Fed Chairman Jerome Powell planning to hold a press conference half an hour later.

The Fed’s Summary of Economic Projections is likely to draw more attention than the policy decision itself as analysts and investors look for evidence of how Fed officials’ views on the outlook have changed since their last forecast in March, when the scope of Trump’s tariff plans was unclear but before he delayed some of his toughest tariffs amid widespread negative market reaction.

In March, Fed officials lowered their forecasts for economic growth this year and raised their expectations for inflation, but maintained their median forecast of two 25 basis point rate cuts this year. Although this interest rate outlook is consistent with December last year, the divergence of views in the Fed's "dot plot" has narrowed. Some analysts expect that given the Fed's emphasis on controlling inflation and expectations that Trump's new tariffs will still lead to higher prices, the dot plot may tilt further toward hawks.

“Trade policy developments may have led to significant changes in the Fed’s forecasts,” Michael Feroli, chief U.S. economist at JP Morgan, wrote on Friday, predicting slower economic growth and higher inflation this year than expected in March.

“These stagflationary revisions do not point in a clear direction for a revision of the dot plot. Even so, we think the dot plot will move slightly in a hawkish direction,” with only one rate cut expected this year.