Fed remains on sidelines

The Federal Reserve left its benchmark fed funds rate unchanged in a target range of 4.25%-4.5%, the third pause since the central bank cut rates three times late last year:

While tariffs were mostly a matter of conjecture at the time of the Fed’s last meeting in mid-March, they have since become a reality—although the uncertainty surrounding them remains extremely high. Since the White House’s April 2 announcement of sweeping tariffs, President Trump has delayed some and reversed others, at least partially.

That uncertainty has been evident in the financial markets. Although both the stock and bond markets have seen volatility decline from its early April highs, many questions remain about the scope and application of tariffs, and their potential impact on the economy and the markets remains unknown.

The potential for tariffs to reignite inflation and slow economic growth has left the Fed in a bind, despite the White House’s repeated criticisms of Fed Chair Jerome Powell for not cutting rates. So far, the economy doesn’t appear to have slowed as much as some analysts feared, although the data hasn’t necessarily begun to reflect tariff impacts.

A Fed that wants “clarity” before acting will likely remain on hold into the second half of the year, if not longer, according to Morgan Stanley & Co. economists. Unless the economy slips into a recession—which the economists do not expect—they think the Fed will wait to cut rates until 2026.¹

The stock market’s rally off its early-April lows suggests investors may have decided to look past tariffs and focus on potential tax breaks and deregulation later this year. But as Morgan Stanley Wealth Management noted, this relief rally may be ignoring the damage that has already been done by tariff uncertainty. That said, in the absence of a recession, the analysts view 5,100–5,500 as a “defensible entry zone” for the S&P 500, and recommend maximum portfolio diversification.²

In the near term, while optimism about a possible trade deal with China arguably fueled the stock market’s rebound to pre-tariff levels, the major indexes may find it difficult to challenge their record highs unless that agreement materializes in the next week to 10 days, according to Morgan Stanley & Co. strategists. But they also think it may require evidence that the Fed is moving in a more dovish direction, which they admit may be a “tough needle to thread,” given expectations for the central bank to remain on hold.³

Note: The Fed’s next policy meeting is scheduled for June 17-18.

¹ MorganStanley.com. May FOMC Preview: Well Positioned to Wait for Greater Clarity. 5/1/25.
² MorganStanley.com. The GIC Weekly: Taking stock. 5/5/25.
³ MorganStanley.com. Weekly Warm-up: What’s Next? 5/5/25.