The US Federal Reserve is waiting to gauge the impact of the administration’s import tariffs on US growth and inflation before making its next move on monetary policy. Meanwhile, Asian central banks could cut their policy rates sooner than the Fed.
A mix of lower inflation and real interest rates above those in the US, recently lower oil prices, current account surpluses and receding concerns over capital outflows could allow the Fed’s Asian counterparts to beat it to the punch. The focus, as always, is on China.
The Fed’s persistent dilemma
The policymaking Federal Open Market Committee (FOMC) kept US rates on hold at its latest meeting. Chair Jerome Powell highlighted the worsening trade-off between growth and inflation caused by the complications from the tariffs. However, he also reiterated that the Fed’s policy was ‘well-positioned’ to respond to the risks to either part of its dual mandate of maximum employment and stable prices.
Indeed, economic data still paints a mixed picture for growth and inflation that leaves the Fed between a rock and a hard place.
Some growth indicators still look fine and argue for no rate cuts. The latest ISM services report showed a faster-than-expected expansion in activity in April (up by 0.8 of a percentage point from March at 51.6).
Non-farm payroll data showed 177,000 jobs were created, which was more than expected. The unemployment rate held steady at 4.2% and the labour participation rate rose (i.e., more Americans are looking for work).
However, other indicators argue for policy easing. They include a contraction in the ISM manufacturing index (at 48.7 in April), a further decline in consumer confidence (the Conference Board index fell by 7.9 points month-on-month to 86 in April), a 0.3% annualised contraction in first-quarter GDP and a declining trend for total employment cost growth (see Exhibit 1).
Meanwhile, the Fed’s key gauge of inflation argues for holding monetary policy steady. The personal consumption expenditures (PCE) index has remained above the Fed’s 2% target: Core PCE inflation was 2.6% YoY in March after 2.7% in February.
Tariffs complicate things
The tariffs on imports have added complications to the policy environment, first by boosting US inflation, if only temporarily, and then by hitting growth given that they are taxes on both consumption and production in the US.
Fed Chair Powell said after the latest policy meeting that the Fed was in no hurry to cut interest rates. Such a cautious stance reflects the view that tariffs are stagflationary – while the economy and labour market are cooling, the Fed is worried that cutting interest rates too soon could add to the inflationary effects.
As we argued recently, the downside risk to growth will likely outweigh the upside risk to inflation because higher tariffs alone will not sustain inflation. Without a commensurate increase in nominal incomes, the higher tariffs will drag on consumption by sapping disposable income, just as taxes do.
Indeed, the US labour market has been softening, with the ratio of job openings-to-unemployed falling steadily since its peak in 2023 (see Exhibit 2). Hence, wage gains have slowed as demand for labour weakens.
Due to this mixed economic backdrop, we see the timing of the next rate cut by the Fed as highly uncertain. There is even a possibility that if tariffs have less of an impact than expected, the Fed could hold rates at current levels until 2026, as some market players are arguing.
Asia may jump the gun
While the Fed waits, Asian central banks march ahead on rate cuts. The banks do not want to cut their policy rates too quickly because it could lead to capital outflows and put depreciation pressure on their currencies. This factor was a key reason for the Bank of Korea pausing its rate-cutting cycle in April.
However, a weaker US dollar (due partly to portfolio rebalancing away from overweight positions in US assets) has lessened concerns over the local currencies. Over the last week, major Asian currencies have actually surged against the dollar on market talk that the region’s governments had agreed to boost their exchange rates as a condition for settling the tariff war with the US.
Meanwhile, China’s measured response to US tariffs with an only modest currency depreciation since the tariffs were announced in early April has helped keep Asian exchange rates relatively stable against the dollar. This is because there are high correlations between the movements of the renminbi and other Asian currencies.
Declines in global energy prices – crude oil prices have fallen by $12 a barrel since January – could also allow Asian central banks to cut rates before the Fed moves. Most Asian countries, except Malaysia and Brunei, are net energy importers. Lower energy prices should help improve their trade balances and contain inflationary pressures.
With real (inflation-adjusted) policy rates still high and inflation low in most of Asia (see Exhibit 3), we believe there is room to frontload rate cuts in 2025.
China eases before trade talks
At a high-profile press conference held by the top three financial regulators, China announced a package of coordinated easing measures prior to the trade talks with the US on 9-12 May in Switzerland.
The measures include cuts in interest rates and the bank reserve requirement ratio, more targeted lending to boost consumption and tech innovation, and the creation of a RMB 800 billion stock market stabilisation facility.
Given the headwinds from higher tariffs, monetary easing is needed to facilitate the implementation of Beijing’s planned fiscal stimulus. The latest move can be seen as a vindication of previous policy pledges to boost growth. Our research team expects more monetary and fiscal easing in the coming months.
We also see the stimulus announcements as a move by China to improve its leverage ahead of the trade talks as Beijing does not expect negotiations to be smooth. Nevertheless, we do expect a de-escalation of the trade tensions in the near term.1
[1] Also see: The US agreed with China during the Geneva negotiations to cut extra tariffs on Chinese imports from 145% to 30% for the next three months, while Chinese duties on US imports will fall to 10% from 125%. China agreed to lift export countermeasures including restrictions on rare earth minerals and magnets used in high-tech manufacturing. Source: https://www.reuters.com/world/china/us-china-reach-deal-slash-tariffs-officials-say-2025-05/
