Stock Market Plummets Most Since May, Following Reduction in Employment and Implementation of Tariffs

Stock Market Plummets Most Since May, Following Reduction in Employment and Implementation of Tariffs

The Federal Reserve finds itself in a delicate position as the tariff war continues to intensify, with potential economic repercussions that could impact its monetary policy decisions.

In a recent development, President Donald Trump announced tariff rates on dozens of countries, pushing back the effective date to August 7. This decision has raised concerns among economists, with Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management, stating that the labor market shows signs of strain due to tariffs.

The Fed, which counts "maximum employment" as one of its two mandates, is closely monitoring these developments. Issues with either goal could prompt a shift in policy. The Fed held rates steady at its most recent meeting this week, but the market's odds of a quarter-point cut in September have risen to around 87%.

The combination of tariffs adding to inflation and slowing economic growth presents a dilemma for the Fed. While higher inflation pressures argue for tighter monetary policy, slower growth and a more challenging business environment risk labor market deterioration. This creates a balancing act for the Fed, with its September decision heavily depending on the labor market data in the upcoming jobs report.

The tariffs, including a 25% tariff on autos and auto parts, increase costs for consumers significantly, pressuring prices upwards. J.P. Morgan forecasts core PCE inflation rising to 3.1% due to these tariffs, while GDP growth slows to about 1.3%. The risk is that this pressures the Fed by forcing a trade-off between containing inflation and supporting growth.

The Budget Lab analysis highlights that the tariffs lead to an overall price level increase equivalent to an average household income loss of around $2,400 in 2025, with lower-income households disproportionately affected. This distributional impact and inflation from tariffs add another factor for the Fed’s consideration in its policy assessment.

The surprisingly weak hiring numbers in July, with employers adding just 73,000 jobs, have led investors to step up their expectations for an interest rate cut in September. The Labor Department reported revisions shaving a stunning 258,000 jobs off May and June payrolls. This unexpected downturn in job growth has added fuel to the expectations for a rate cut, with the yield on the two-year Treasury, which more closely tracks expectations for Fed actions, plunging to 3.68% from 3.94% after the report's release.

The Fed has held rates steady since December, but the current economic climate could force its hand. Companies are finding it difficult to make forecasts due to the policy with some tariffs already in effect while others change or get extended. The Fed Chair Jerome Powell has been pressured by Trump to cut the benchmark rate, but the decision is not his alone, but belongs to the 12 members of the Federal Open Market Committee.

In conclusion, the tariff tensions are creating a challenging environment for the Federal Reserve. The forthcoming jobs report will be critical in determining whether the Fed sees enough labor market strength to keep interest rates steady or opts for cuts to counteract economic weakness induced by tariffs. The decision will undoubtedly have far-reaching implications for the U.S. economy and global markets.

[1] Source: CNBC, Bloomberg, and Budget Lab analysis [2] Source: CNBC [3] Source: Bloomberg [4] Source: Federal Reserve minutes from June meeting

1. The tariff war's effects on business, finance, and the general news are intricately linked, as the Fed's monetary policy decisions could be influenced by the potential economic repercussions, particularly the impact on employment and inflation.
2. The ongoing tension in politics, specifically tariff policies, is causing a conundrum for the Federal Reserve, especially in relation to balancing inflation concerns from increased costs (such as auto prices) with the risk of slowing economic growth, which might negatively affect the labor market.

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