For the past several years, the Federal Reserve has been the dominant policy force in US markets and the economy, but that dynamic, is shifting. In less than two months, the new administration has taken an aggressive approach to trade and fiscal policy, significantly altering economic expectations. With the next Federal Open Market Committee (FOMC) meeting less than a week away, markets are weighing whether the Fed will adjust its policy stance (unlikely) and, more importantly, what guidance they provide for the remainder of 2025 amid an ever-changing landscape.
Trade Policy Uncertainty and Market Reaction
President Trump’s on-again, off-again tariff announcements have created heightened uncertainty in financial markets and upended economic forecasts. The Economic Policy Uncertainty Index has surged to its highest levels on record to start the year (chart below), reflecting growing concerns from businesses, both domestic and globally, shaking household confidence and sending market volatility soaring.
Historical Precedent: Déjà Vu?
Does the current market environment signal a prolonged downturn? While uncertainty often breeds pessimism, one historical comparison suggests that market participants may be overreacting. As the chart below illustrates, President Trump’s previous tariff implementation during his first term led to a similar initial market response before a sharp rebound. However, the broader economic backdrop is very different today and must be considered before drawing direct parallels.
Image Source: Zacks Investment Research [Green Line – March 2019 – December 2019. Red Line Jan 2025 – March 6, 2025]
This Time is Different
Unlike the tariff measures of 2017-2018, today’s economy is in a weaker position to absorb additional trade shocks. Our partners at The Leuthold Group highlight these distinctions in their March 2025 Green Book:
“While a review of the impact of tariffs implemented in 2017 and 2018 is worthwhile, the critical consideration is that back then, the economy was much better positioned to absorb the tariffs, themselves—and the confusion surrounding them. That was especially true in the U.S. manufacturing sector. The ISM New Orders Index—one of the ten inputs to the recently-discredited Index of Leading Economic Indicators—was at 60 or above during the 2017-18 period, and the LEI’s six-month annualized rate of change averaged a solid 6.0%. Fast forward to 2025, January’s LEI reading was -1.8%, and that was before another key component of the LEI—the 10-Yr./3-Mo. Treasury yield spread—inverted again in late February. With growth in real personal disposable income today running at about half the level seen when the first tariffs were imposed in 2017, the ability of consumers to absorb any price hikes is questionable.
Our main concern with tariffs is their potential blow to an expansion that in many ways still looks “pre-recessionary.” But if tariffs are broadly implemented, they’ll prove to be a short-term boost to inflation as well. Again, the tariff timing is much less convenient than in the last cycle, when policymakers viewed the era’s unduly low inflation rate as their most vexing challenge. That obstacle was faced and subsequently conquered. But the ensuing conundrum to cut inflation back to the 2% level has proven equally vexing, and the tariffs figure to impede that effort.”
The Fed’s Uncertain Path
Caught in the midst of shifting fiscal policies and market turbulence, the Federal Reserve faces a difficult balancing act. With its next meeting less than a week away, policymakers must assess the economic impact of new tariffs, inflationary risks, and labor market conditions. However, historical trends suggest that betting on market expectations for rate policy often proves unreliable (chart below).
Fed Chair Jerome Powell acknowledged this uncertainty in his most recent remarks, reinforcing the likelihood that the central bank will maintain a cautious stance until the economic picture becomes clearer:
“While there have been recent developments in some of these areas, especially trade policy, uncertainty around the changes and their likely effects remains high,” Powell said. “As we parse the incoming information, we are focused on separating the signal from the noise as the outlook evolves. We do not need to be in a hurry, and are well positioned to wait for greater clarity.”
Fiscal Policy Takes Center Stage
The influence of the Federal Reserve on market direction may be waning as fiscal policy becomes the primary driver of economic conditions. The administration clearly intends to set the tone through trade decisions and regulatory shifts, while monetary policymakers find themselves reacting rather than leading. This shift may leave the Fed on the sidelines for much of the year, reducing its role as the primary force steering financial markets. The market’s reaction (or inaction) to next week’s FOMC meeting will be telling.
Conclusion
Periods of uncertainty tend to result in heightened market volatility. Whether this latest trade dispute follows the same trajectory as previous tariff episodes—leading to a market rebound—or whether it causes more prolonged losses remains to be seen. Regardless, volatility is likely to persist in the coming weeks and months. Tactical investment strategies that can adapt to rapid shifts in the market landscape may prove particularly useful in navigating this environment.
