In June 2023, after a photo taken at a concert had circulated on social networks, the chair of the US Federal Reserve acknowledged he had been a fan of California rock band The Grateful Dead for 50 years. More recently, on April 16, he again dipped into pop culture, ending a speech on the economic outlook with a quote from Ferris Bueller’s Day off, ‘Life moves pretty fast,’ to underscore how hard it is to make forecasts.
Jerome Powell also reminded his audience that the Fed was well positioned to wait for the ‘tariff dust’ to settle before considering any adjustment to its monetary policy.
Enthusiasts of Ferris Bueller’s Day off will recall that the high school senior played by Matthew Broderick on his day off missed an economics course in which the professor discussed to what extent the Hawley Smoot Act (which massively raised US tariffs in 1930) aggravated the Great Depression.
We will never know if this movie reference set off President Donald Trump’s diatribe inviting Jerome ‘Too late’ Powell to cut key rates now. Chair Powell’s term as Fed chair is due to end in May 2026. Trump’s comments are seen as calling into question the independence of the Fed.
After new harsh comments by President Trump on 21 April, the US equity market dropped 2.4% (for the broad S&P 500 index). The criticism from the White House also weighed on the US dollar in currency markets. President Trump later toned down his comments, claiming he ‘never’ had any intention to fire Powell, but again pressed the Fed chair to cut interest rates, saying now was a good time.
During her press conference on 17 April, European Central Bank (ECB) President Christine Lagarde had pointed out that central bank independence was essential and expressed her solidarity with Powell.
Leaving aside politically motivated pressure, what did central banks choose to tell us last week and what might they be telling us in the coming months?
‘Unusually’ challenging forecasts
This message came from the Bank of Canada’s (BoC) on April 16. It explicitly referred to ‘the major shift in direction of US trade policy and the unpredictability of tariffs’. The BoC explained that it had drawn up two scenarios for the path US trade policy could take and its impact on the economy.
Two days earlier, Fed Governor Christopher Waller had engaged in the same exercise, explaining that long-lasting tariffs at 25% would mark a fundamental turning point for the US economy with a rapid rise in inflation, a significant slowdown in growth and rising unemployment.
The more favourable scenario would see most of the announced imports levies withdrawn, leaving an average tariff rate of around 10% (compared to 2.3% in 2024 as measured by the ratio of duties collected to US imports). In this case, inflation would temporarily rise to 3% before returning to 2%, the negative effect on growth would be limited and unemployment would be stable.
While high tariffs – and high inflation – would threaten economic growth and raise the risk of recession, thus causing the Fed to cut policy rates, a more benign course of events – falling demand and less pressure in inflation – would allow it to maintain the ‘patient’ approach to further rate cuts that it has pursued since the beginning of the year.
Governor Waller clarified: ‘Yes, I am saying that I expect that elevated inflation would be temporary, and ‘temporary’ is another word for transitory’. This comment reassured investors after Jerome Powell’s earlier hawkish comments.
Inflationary expectations could be crucial
Not all central bankers share this view whereby inflation will not necessarily prevent rate cuts. The BoC’s position is that ‘monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war. What it can and must do is maintain price stability for Canadians’.
The ECB, which lowered its key rates by 25bp on 17 April (and no longer refers to its monetary policy as restrictive with the deposit rate now at 2.25%), reiterated its view that the disinflationary process is well on track although ‘the economic outlook is clouded by exceptional uncertainty’.
Beyond the usual wording about the need for a ‘meeting by meeting’ policy approach, President Lagarde said that “there is no better time to be data dependent”, adding that the ECB must stand ‘ready for the unpredictable’.
The ECB survey of professional forecasters (SFP) for the second quarter of 2025 showed a slightly upward revision (+0.1pp) for core inflation for 2025-2027 with an unchanged median for longer-term expectations.
A supply shock to the US economy
If we put to one side the possibility of adjustments to the level of tariffs imposed on US imports, the new administration’s protectionist trade policy can be seen as a negative supply shock to the US economy (via a fall in goods entering the US, disruptions to supply chains and a sharp rise in production costs).
For the rest of the world (and in the absence of large-scale tariff retaliation), this is a demand shock. This is indeed seen as the aim of the Trump administration which has focused its barrage of tariffs on those countries with large trade surpluses in their trade balance with the US).
It is easier for a central bank to respond to a demand shock since the result is a slowdown in activity with lower prices. A supply shock can lead to higher prices despite depressed activity, also known as stagflation. This is why Jerome Powell has warned that even if tariffs are highly likely to generate at least a temporary rise in inflation, the effect could also persist. In that case, the Fed would find itself in ‘a challenging scenario in which the dual mandate goals are under tension’.
His message on the nature of tariff-related inflation has become increasingly cautious in recent weeks.
The minutes of the March meeting of the committee of Fed policymakers reflected the same concerns over the pattern on inflation in the coming months: Some participants observed that the committee may face ‘difficult tradeoffs’ if inflation proved to be more persistent while the outlook for growth and employment weakened.
Multiple uncertainties elsewhere
In its April Monetary Policy Report, the BoC distinguishes ‘two layers of trade uncertainty.’
The first is well identified and should be resolved over time. It concerns the nature and extent of the tariffs imposed by the US and any countermeasures taken by US trading partners, how long they last, and the outcome of future trade negotiations.
The second layer of uncertainty concerns the reaction of economic agents to these many uncertainties and their consequences.
The lack of visibility over how households and businesses would adapt to tariffs is the reason the demand shock looming outside the US could prove tricky for central banks to manage.
To suggest, as ECB President Lagarde did, that monetary easing should continue is likely to reassure economic agents, showing confidence in the downward path of inflation and recalling that risks to growth are on the downside.
Governor of the Banque de France François Villeroy de Galhau said that inflation risk related to trade tensions appeared ‘rather low‘ and ‘it may be ‘even on the downside’.
The dovish message from the ECB has been received loud and clear (see Exhibit 2): Given the significant downside risks to growth, and the substantial trade policy uncertainty, the bar for the ECB to keep on cutting interest rates is low. Indeed, markets and economists are forecasting a series of rate cuts by the end of the year.
An interesting comment was made about the level of the neutral rate of interest during the latest ECB press conference. President Lagarde reiterated that the concept of a neutral rate is useful in a world that is not subject to a shock since it is by definition the policy rate that would have no effect on a balanced economy.
Clearly, the shocks investors and markets have experienced since the start of the year will reverberate for many months to come. Such a remark by the ECB President could be seen as a means of limiting any internal debate that could prevent what French central banker François Villeroy de Galhau described as ‘agile pragmatism’.
Beyond the macroeconomic factors discussed above, investors can trigger unprecedented shocks such as a massive (sudden or rampant) disaffection for US dollar-denominated assets.
Jerome Powell noted on 16 April that ‘markets are orderly and they’re functioning just about, as you would expect them to function’ in the context of the high uncertainty.
He concluded that intervention was not necessary, while stressing that the Fed is ‘absolutely’ ready to supply US dollar liquidity to other central banks via its swap lines if necessary.
The Governor of the Banque de France sees the current environment as a ‘rough sea’ that requires a clear course and a solid navigation map.
Let us hope that the central bankers will not have to quote a line from Steven Spielberg’s Jaws. This famous line is employed when it is clear that one’s toolbox is inadequate to solve the problems that have arisen: ‘You’re gonna need a bigger boat.’
