Tariffs Keep The Federal Reserve Focused On Inflation, But No Change Is Expected For Interest Rates
By James Picerno | The Milwaukee Company
The Fed remains in a “wait and see” mode, relying on preemptive policy cuts from last fall to minimize inflation.
The path ahead for tariffs is still a wild card for the Fed with respect to inflation’s path in the months ahead.
Fed Governor Waller expects that any tariff-related inflation will be temporary.
Judging by the recent decline in the policy-sensitive US 2-year Treasury yield and Fed funds futures, market expectations continue to anticipate a rate cut, if not at next month’s policy meeting then by June. TMC Research’s Fed Funds Model also suggests that easing monetary policy is appropriate, based on current conditions. But Federal Reserve officials continue to downplay expectations that a rate cut is near. A key factor: tariffs could elevate prices.
Federal Reserve governor Chris Waller is the latest in a series of policy officials who are talking up the goal of keeping inflation stable. That task could become more challenging in the near term due to tariffs, he explained on Monday. Higher inflation implies rate hikes. But Waller also said that he expects any inflation increase triggered by tariffs will be temporary due to the countereffects of slower growth and higher unemployment.
Under the large tariff scenario, economic growth is likely to slow to a crawl and significantly raise the unemployment rate. I do expect inflation to rise significantly, but if inflation expectations remain well anchored, I also expect inflation to return to a more moderate level in 2026. Inflation could rise starting in a few months and then move back down toward our target possibly as early as by the end of this year.
He added that it’s not yet clear that rate hikes will be necessary.
The preemptive policy cuts we did last fall can allow us some time to wait and see if the hard data catch up to the soft data or vice versa and how much of the tariff will be passed through to the consumer. In such a scenario, the outlook for monetary policy might not look much different than it did before March 1.
Two recent surveys of inflation expectations suggest that consumers are expecting prices to rise, which can be a self-fulling prophecy. Notably, the initial April estimate of inflation expectations in the University of Michigan’s widely followed poll surged to 6.7%. By contrast, the New York Fed’s consumer survey is substantially lower at 3.6% for the year-ahead outlook, albeit as of March. Both numbers are well above the reported 2.6% consumer inflation year-over-year trend through March, which in turn is moderately above the Fed’s 2% inflation target.
Waller noted that he places more trust in the Treasury market’s implied inflation forecast for expectations. The 5-year breakeven inflation rate, based on the nominal 5-year yield less its 5-year counterpart, was 2.31% on Monday (Apr. 15), which is roughly in line with the pre-tariff turmoil.
TMC Research’s Fed funds model shows a widening spread between the current median Fed funds target rate and the falling estimate of a neutral rate – a sign that Fed policy may be passively shifting to a more restrictive phase lately, albeit on the margins so far.
What could change the calculus and move Waller (and presumably the Fed) to consider rate hikes? Stronger growth in the labor market could be a trigger.
Meantime, the Fed appears to be watching and waiting for more data and allow the current policy stance to continue for the near term. The wild card is still tariffs, and these are still early days. For now, the central bank seems to be comfortable with maintaining its current 4.25%-to-4.50% Fed funds target range until inflation and/or the labor market data provides a compelling reason to change tack.