Transitory Inflation & Rate Debate: What You Need to Know
Tariffs’ Gradual Inflationary Grip: A Growing Concern for the Fed
The subtle, yet persistent, upward pressure of tariffs on inflation is a growing concern for policymakers, possibly complicating the federal Reserve’s delicate balancing act. While companies may not pass on the full cost of tariffs immediately, a gradual absorption of these costs is highly likely to fuel inflation for an extended period, according to Alberto Cavallo, a Harvard University professor who has developed a model to track the price impact of tariffs.
“They’re going to do it gradually,” cavallo explained. “And that gradualness tends to push inflation upward for a meaningful amount of time.” This gradual inflationary creep is of immense importance to global markets, investors, and consumers, who have already endured significant hardship. The aftermath of the COVID-19 pandemic, marked by easy monetary policies and supply chain disruptions, had already propelled inflation to levels not seen in a generation.
Unhappiness with these high prices was a significant factor in Donald Trump‘s presidential election victory. Trump has frequently voiced his displeasure with interest rate policies, directing particular ire at Federal Reserve Chair Jay Powell. This has led some investors to express concerns about the independence of the central bank.
With Trump advocating for interest rate cuts of as much as 3 percentage points, even as the economy shows resilience, some economists and investors warn of a potential repeat of post-pandemic inflationary surges. “It makes sense for the Federal Reserve to wait and see before they make a big decision,” Cavallo advised.
Contradictory Findings Fuel Debate
Cavallo’s ongoing research, which analyzes pricing data from four large U.S. retailers and is updated to reflect changes in tariff levels, has revealed “rapid pricing responses, though their magnitude remains modest relative to the announced tariff rates and varies by country of origin.” As of July 14, his analysis indicated this trend.These findings align with other efforts to dissect the complexities behind aggregate inflation figures. A May paper by Federal Reserve economists, examining the closely watched Personal Consumption Expenditures (PCE) price index, indicated that tariffs on Chinese imports in February and March had already begun to impact consumer prices.
However, the management has presented a contrasting view. The Council of Economic Advisers, the White House’s think tank, utilizing methodologies similar to the Fed paper, published findings earlier this month suggesting that prices of imported goods had actually fallen this year.
Both sets of research acknowledge limitations, and neither offers a definitive, complete picture of the current economic landscape. The debate over the true impact of tariffs is also beginning to create divisions within the Federal Reserve itself. Fed Governor Chris Waller, considered a potential successor to Powell, has expressed a preference for a rate cut at the July meeting, believing tariffs will have a limited effect on inflation and concerned about a slowdown in economic growth and private sector hiring.Conversely, others, such as New York Fed President John Williams, have urged caution, emphasizing that it is still too early to draw firm conclusions.Thierry Wizman, Global FX & Rates strategist at Macquarie Group, noted in a recent client note that “Comments coming from Fed officials suggest that the FOMC is cleaving.” He further elaborated that this division could “evolve into a split along political lines, with one side swayed by political motives, and the need to accommodate fiscal policy, at the expense of adherence to the price stability mandate.” Such a scenario, Wizman warned, “would contribute to U.S. yield-curve steepening.”