The Federal Reserve has kept its key interest rate unchanged, but its chairman Jerome Powell warns that sustained tariffs on trade partners could lead to higher inflation, slower growth, and increased unemployment.

The federal funds target rate was left at 4.25% to 4.5% for the third straight meeting of the policy-making Federal Open Market Committee on May 7 ( early Thursday morning in Hong Kong ), after being cut three times in a row last year. The latest decision  reflects the US central bank’s cautious approach amid economic uncertainties, particularly those arising from President Donald Trump's tariff policies.

“If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment,” Powell says.

The Fed chairman, however, qualifies that the impact of inflation could be short-lived or more persistent, depending on the size of the tariffs and how long it will take for them to be fully passed on to prices. 

Supply chain disruptions

“If the current elevated tariffs on US-China trade stay in place, we think the ensuing supply chain disruptions will likely result in a supply-driven contraction in the US this year,” says Jean Boivin, head of the BlackRock Investment Institute. “That’s very different from a typical recession caused by weakening demand and more akin to what we saw in the pandemic.”

Ray Sharma-Ong, head of multi-asset investment solutions, Southeast Asia, at Aberdeen Investments, comments: “This makes it harder for the Fed to cut rates pre-emptively to support economic growth because the risk of inflation is high due to the impact of the tariffs.”

For investors, this means that portfolios built on rate cut optimism are now exposed to risk because they were structured with the expectation that the Fed would significantly lower interest rates in the near term.

Portfolios whose asset allocation is built on rate-sensitive assets would be more exposed to risks in the wake of delays in interest rate cuts.

Such assets would include long-duration bonds, which lose value when rates stay high, growth stocks, which are valued based on future earnings and are discounted more heavily in a high-rate environment, as well as high-beta sectors like technology or real estate.

“Markets continuously re-price assets based on the expected path of interest rates,” one analyst notes. “If traders start to believe that rate cuts won't happen as soon or as deeply as anticipated, there’s a risk of a broad market pullback, especially in sectors that rallied on dovish expectations.”

Rate-sensitive assets

Currently, many portfolios are tilted towards long-dated bonds or assets sensitive to the yield curve; they may suffer if the yield curve steepens unexpectedly, especially if short-term rates remain “higher for longer” while long-term rates adjust upwards.

Also, many investors are invested heavily in the same themes, such as tech stocks and duration-heavy assets, which are vulnerable to sharp corrections when the market narrative changes.

In the wake of the delay in rate cuts, Sharma-Ong says Aberdeen’s investment preference is for regions outside of the United States, such as Europe and China, which have strong fiscal and monetary support.

“While we still expect rate cuts this year, they are likely to occur towards the end of the year, when hard data is likely to deteriorate,” says David Chao, global market strategist, Asia Pacific ex-Japan, at Invesco.