What to Watch at the Federal Reserve’s May Meeting-OxBig News Network

The Federal Reserve is set to extend its pause on interest rate cuts on Wednesday amid concerns that President Trump’s tariffs will unleash fresh inflationary pressures while also hurting growth, a tricky combination that could lead to painful trade-offs for the central bank.

A decision to stand pat would keep interest rates at 4.25 percent to 4.5 percent, a level reached in December after a series of cuts in the second half of 2024.

Fed officials are in wait-and-see mode for now. They are closely tracking the incoming data for signs that consumer prices are rising again after a multiyear battle to keep them at bay, or that an otherwise solid labor market is starting to weaken. What they need is greater clarity on what, exactly, Mr. Trump has in store for the economy after a whirlwind of tariff announcements, government spending cuts and deportations.

The Fed will release its latest policy statement on Wednesday at 2 p.m. in Washington. Jerome H. Powell, the Fed chair, will hold a news conference right after.

Here is what to watch for on Wednesday.

Temporary or Persistent?

Mr. Trump’s tariffs are widely expected to raise consumer prices, but the question is whether this will be a one-off increase or feed into a more persistent inflation problem. The answer will determine how carefully the Fed will proceed in terms of lowering interest rates.

At the last meeting in March, Mr. Powell told reporters that the Fed’s base case was for tariff-induced inflation to be “transitory,” reviving a term that gained notoriety after the Fed and other forecasters used it to initially describe price pressures during the pandemic. Those ended up causing the worst inflation spike in decades.

But that was before Mr. Trump shocked the world with far steeper tariffs than many had expected. The levies were temporarily scaled back as Mr. Trump gave countries time to reach trade deals ahead of a July deadline. Still, a 10 percent universal tariff remains in place, along with additional levies on steel, aluminum and cars. The president has also imposed a minimum tariff of 145 percent on Chinese goods.

Mr. Powell has since shifted his tone, sounding much more attentive to the risks that the inflationary effects will not fade quickly.

“Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem,” he said in a speech last month.

On Wednesday, he is likely to face questions about the Fed’s latest thinking on inflation, which eased more than expected in March.

So far, market-based measures of inflation expectations, which the Fed pays closest attention to, suggest that inflation will indeed remain contained after an initial jump. That aligns with the forecast from Christopher J. Waller, a Fed governor who has been among the most vocal supporters of the view that tariffs will cause just a temporary pop in inflation.

Yet even he has conceded that it will not be easy to look past surging prices when they finally materialize.

“It’s going to take some courage to stare down these tariff increases in prices with the belief that they are transitory,” he said in an interview last month.

High Bar to Cut

With Mr. Trump’s tariffs potentially stoking inflation, the bar for the central bank to lower interest rates is higher than would otherwise be the case.

Officials have signaled that they will not proactively restart interest rate cuts, in a departure from how they handled the prospects of an economic downturn in the past.

Back in September, the Fed, in effect, took out insurance against the labor market’s excessively weakening by lowering interest rates half a percentage point. And in 2019, it lowered interest rates three times as Mr. Trump’s global trade war with China in his first presidential term began to chill business activity and weigh on sentiment.

In both instances, inflation was at much lower risk of flaring up. The Fed does not have that luxury this time around.

“I would rather be slow and move in the right direction than move quickly in the wrong direction,” said Beth Hammack, the president of the Federal Reserve Bank of Cleveland.

What exactly will tip the Fed into cutting again is not yet clear. In general terms, officials will most likely need to see tangible evidence that the labor market is beginning to crack. If monthly jobs growth grinds to a halt and layoffs rise, that would bolster the central bank’s conviction that it could lower interest rates without risking a resurgence in inflation.

Waiting to see that show up in the data may mean the Fed has moved too late, potentially prompting the need for officials to cut more aggressively later on.

Mr. Powell may provide more specificity about what exactly the Fed needs to see in order to lower interest rates again and how the central bank will avoid making a policy error.

Tricky Trade-Offs

Compared with the current circumstances, past policy decisions have seemed relatively straightforward.

When inflation surged and the labor market overheated after the pandemic, there was little hand-wringing over the decision to sharply raise interest rates once the process had started. Back in September, when inflation was in retreat and the labor market was cooling off, officials all recognized the need to lower interest rates. While there was debate over the size of the cut, the direction of travel was clear.

But Mr. Trump’s economic agenda of sweeping tariffs, spending cuts and mass deportations risks stoking inflation while also denting growth, a dreadful combination for the central bank, which essentially has one blunt tool to steer the economy, lowering or raising interest rates.

Mr. Powell warned about the possibility that the Fed’s goals for low and stable inflation as well as a healthy labor market could come in tension with each other. Such an outcome, he said, would prompt a “very difficult judgment” for the central bank.

“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,” he said. What he did not specify was how the Fed would go about making that assessment, something that is likely to come up at the news conference.

Volatile Financial Markets

Since the Fed’s last meeting, financial markets have violently whipped around as Wall Street has struggled to digest the various twists and turns associated with Mr. Trump’s trade policy.

At several points last month, typical correlations started to break down, signaling that financial markets had come under strain. The most worrying development was a surge in U.S. government bond yields as the dollar weakened and stocks sold off. Typically Treasuries and the dollar act as safe havens during times of financial turmoil.

Markets have stabilized in recent weeks, but the severity of the earlier moves has kept investors on edge. Fed officials at the time signaled that the central bank was monitoring the situation closely and broadly concluded that financial markets were still functioning. At the peak of the volatility, Susan Collins, president of the Boston Fed, said the central bank was “absolutely” ready to intervene if necessary.

Mr. Powell is likely to be asked about the recent gyrations and the conditions under which the Fed would intervene if that volatility resurfaced.