Shmid warned that “while in theory, tariffs may have only temporary effects on inflation (although persistent effects on the level of prices) I would be hesitant to take too much solace from theory in this environment”. He tied recent tariff announcements to broader signs of economic stress, including “a decline in consumer sentiment and increases in near-term inflation expectations.” Schmid acknowledged that the current policy environment has become “considerably more complicated,” citing feedback from business contacts who see growing risks on both sides of the Fed’s dual mandate of maximum employment and stable prices.

Schmid’s skepticism around transitory inflation contrasts with recent remarks from Fed Chair Jerome Powell, who has leaned into a more reassuring message about the persistence of tariff-driven price pressures. In “Jerome Powell’s Fed Deftly Maneuvers Through a Stagflationary Minefield“, I admired Powell’s effectiveness in navigating a difficult policy landscape, but I also pointed out the problematic use of “transitory” to describe inflationary effects. Powell argued that “it can be the case that it’s appropriate sometimes to look through inflation if it’s going to go away quickly without action by us… and that can be the case in the case of tariff inflation.”

That assertion paralleled Treasury Secretary Scott Bessent’s line that tariffs are a “one-time price adjustment.” But as I wrote in “The Sleight of Hand Behind the ‘One-Time Adjustment’ and ‘Transitory’ Tariff Inflation Narrative“, for inflation to be transitory, expectations for price levels would need to revert after the initial tariff shock. Yet, “tariffs make price reversion unlikely by locking in a permanently higher cost base.” In that piece, I also pointed out how structural effects – such as wage responses, supply chain disruptions, and embedded cost pass-through behavior – make inflationary pressures from tariffs more persistent. Outcomes are also hard to anticipate as inflationary pressures cascade through the economy.

Schmid appears attuned to these systemic effects. He described “a marked increase in the upside risks around inflation along with elevated downside risks to the outlook for employment and growth,” and openly questioned the prudence of discounting these risks as fleeting. Unlike Powell, who focused on optionality and emphasized that longer-term inflation expectations remain anchored, Schmid directly acknowledged that business sentiment and price expectations are shifting in ways that could prove difficult to reverse.

Powell’s message was strategically designed to preserve policy flexibility and calm markets in the face of stagflationary fears, and in that moment, Powell succeeded. However, I remain concerned that Powell’s framing underestimates the lasting damage that tariff-related cost increases can impose on the economy. As I wrote in my critique, the idea of a “one-time adjustment” may be statistically correct but economically misleading. A new, higher price level, once established, may not simply fade away. The higher price level could reshape business behavior and household expectations for years to come.

Schmid seems to understand these risks. His closing words underscore the seriousness of the moment (emphasis mine): “With renewed price pressures likely, I am not willing to take any chances when it comes to maintaining the Fed’s credibility on inflation.” That statement signals a shift away from the complacency that defines the transitory inflation narrative on tariffs.

The Last Friendly Report on Inflation?

As the Fed slowly accepts increased inflationary risks in the future, the past provides fleeting reasons for optimism on inflation. While I have stuck by the persistent and sticky narrative on inflation, March’s CPI (Consumer Price Index) report signaled the potential start of the next leg down for core inflation…just in time for tariffs to pressure inflation upward again. From the report:

“The index for all items less food and energy rose 0.1 percent in March, following a 0.2-percent increase in February. Indexes that increased over the month include personal care, medical care, education, apparel, and new vehicles. The indexes for airline fares, motor vehicle insurance, used cars and trucks, and recreation were among the major indexes that decreased in March…

The all items less food and energy index rose 2.8 percent over the last 12 months, the smallest
12-month increase since March 2021.”

Notably, the shelter index was up 4.0% year-over-year.

The chart below suggests that, absent tariff inflationary pressures, core CPI would finally be on its last leg lower toward the Fed’s 2.0% target.

Ironically, this positive development in core CPI could give more confidence to policymakers in pressing forward with inflationary tariffs.

Bostic Concurs

In an interview on Marketplace, president and CEO of the Federal Reserve Bank of Atlanta, Raphael Bostic, appeared to concur with Schmid’s concerns:

“I think the pressures that are out there are not the best for our mandates. All the models say that the introduction to tariffs is going to put upward pressure on prices, and I’ve seen more reports of recession fears in the media and from our business contacts than I’ve heard in a year and a half or two years. And so that’s also going to put pressure on our mandate, the employment mandate, in a way that is not positive.”

Bostic’s tiny source of solace is that “the current environment today might not be the current environment tomorrow.”

Currency Correction

Typically I conclude these inflation reviews by teasing out some implications and impacts in currency markets via the U.S. dollar. This time around, there are too many tariff-related cross-currents and too much economic chaos to directly connect dots. So, instead, I take this time to describe a “currency correction” I had to make on the Canadian dollar (USD/CAD) and the Mexican peso (USD/MXN).

A month ago I explained:

“I am short USD/MXN out of a belief that economic relations with Mexico are about as bad as they can get. I could of course get proven wrong in due time. On the other hand, I am long USD/CAD because I do not think the market fully appreciates how much weaker the Canadian economy will get as it tries to match the U.S. in this economic warfare.”

I was correct for almost two weeks, but in due time I have been proven wrong. I have now closed out both trades in order to reassess my next moves. Surprisingly, the Canadian dollar has proven quite strong against the Mexican peso. The exact opposite of my expectations. That chart below shows how CAD/MXN is breaking out from an approximate triangle or wedge type pattern.

Even more importantly, USD/CAD has broken below a key support level at the same time the U.S. dollar looks poised for a fresh, major breakout against the Mexican peso. In other words, in the last 2-3 weeks, I could not have been more wrong! (Note how the 25% tariff on Canada and Mexico defined a PEAK for USD/CAD, a classic contrarian move).

While USD/CAD broke support at its 200-day moving average (DMA) (the blue line), USD/MXN HELD 200DMA support. Thus, USD/MXN looks likelyly to head even higher while USD/CAD looks likely to head even lower.

This currency correction took me by surprise. The move likely reflects the effectiveness and the robustness of Canada’s current resistance to U.S. economic warfare. Mark Carney, the new Prime Minister of Canada, has been quite clear in laying out a framework of Canadian resistance. The Governor of the Bank of Canada, Tim Macklem, has been similarly forthright in laying out the implications for monetary policy and bracing Canadians for the economic warfare ahead. Apparently, both men have, so far, succeeded in bolstering Canada’s defenses (symbolically through the Canadian dollar). The implications for inflation both here and in Canada remain to be seen as trade slows down between the two North American neighbors and former allies.

Be careful out there!

Full disclosure: no positions

The post Inflation Concerns Rise at the Federal Reserve Amid Tariff Unease appeared first on Inflation Watch.

However, a systemic perspective greatly weakens claims of a one-time adjustment. Over time, tariffs can create a cascading effect through the economy, especially when tariffs are broadly applied across a wide swath of goods and services. Over time, tariffs can embed and entrench inflationary pressure in the economy from the following:

• Wage pressures – workers may demand higher wages to compensate for persistently higher consumer costs.
• Supply chain adjustments – companies may shift to more expensive domestic or alternative suppliers.
• Cost pass-through effects – producers adjusting pricing behavior in response to permanently higher costs as they enjoy greater pricing power amid a reduction in alternatives.

Moreover, successive rounds of tariffs, as the economy is experiencing now, amplify inflationary ripple effects, making them harder to unwind.

Still, that one-time adjustment is higher and persistent. So I am skeptical as Bessent also tries to resurrect “team transitory” when explaining the impact of tariffs. For inflation to be transitory, price levels would need to revert after the initial tariff shock. Tariffs make price reversion unlikely by locking in a permanently higher cost base unless offset by productivity gains, currency shifts, or supply chain innovations. Again, all else being equal, as long as the tariff is in place, someone is paying the cost, this year, the next year, and so on. The price increase will not disappear on its own accord. If you are still complaining about how much higher prices are now compared to 2019, you will find yourself complaining years out about the higher prices brought on by tariffs passed on to the consumer level.

Can pandemic-era inflation be described as a one-time adjustment? Of course. All we need to do is extend the time period over which “one-time” applies. The chart below shows the year-over-year change in the average annual CPI. Even if inflation slows to its pre-pandemic pace by 2026, the accumulated price increases remain, permanently raising the cost of living (of course, I have my doubts about the pace of inflation’s decline given the underlying stickiness of key inflationary components). In 2027, a casual observer could look back and conclude this inflationary era was a one-time price adjustment that lasted about 5 years. While the conclusion would be technically correct, the broad price level remains significantly elevated, straining household budgets long after the inflationary event passes. In other words, a “one-time adjustment” in this context is only academically meaningful.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis; March 7, 2025.

Terms like “transitory” and “one-time adjustment” do not speak to the direct and real-time impacts on consumers. These terms are sleights of hand to convince financial markets to look through the price dynamics. Consumers cannot look through these impacts. They must immediately adjust spending habits to account for the deterioration in spending power from tariffs, especially broad based ones (all else being equal).

Adjustments and Transitory Effects In Currency Markets

In foreign exchange, the Canadian dollar and the Mexican peso have served as ground zero for the current chaos over ever-changing policies on tariffs and economic warfare. However, overall, against the U.S. dollar, these currencies have stuck to a well-defined trading range. Against the U.S. dollar, the peso was trading at these same levels four months ago with a 5% trading range from bottom to top (excluding outliers). Against the U.S. dollar, the Canadian dollar was trading at these same levels three months ago with a 2.6% trading range from bottom to top (excluding outliers). On the biggest single-day of volatility, the day tariffs were delayed for a month right before they were scheduled to take effect, USD/MXN traded through a 4.7% range and USD/CAD traded through a 2.8% range. In other words, both currencies covered their entire range of volatility in one day.

These percentages are large in foreign exchange. The adjustments can be seen in the persistently elevated levels for both USD/MXN and USD/CAD. There is no transitory observation until the volatility dies down and/or the price adjustment itself reverses. In the meantime, I am short USD/MXN out of a belief that economic relations with Mexico are about as bad as they can get. I could of course get proven wrong in due time. On the other hand, I am long USD/CAD because I do not think the market fully appreciates how much weaker the Canadian economy will get as it tries to match the U.S. in this economic warfare. Combined, these two trades are good pair trades where I collect interest income from USD/MXN as I wait. Week-to-week volatility in USD/CAD allows me to execute a few swing trades.

Epilogue

Last week I spent more time understanding the economic theories and frameworks espoused by Bessent. The interview at the Economic Club of New York with Larry Kudlow was educational in that respect. Unfortunately, the recording started after the commentary on tariffs. Minus the cheap shots, the rest of the interview is worth watching and understanding.

Be careful out there!

Full disclosure: long USD/CAD, short USD/MXN

The post The Sleight of Hand Behind the ‘One-Time Adjustment’ and ‘Transitory’ Tariff Inflation Narrative appeared first on Inflation Watch.

The chart below shows the change in PCE in the red (and lower) line. The change in the CPI is in the blue (and higher) line.

Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024. U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024.

Who is paying attention to the stabilizing trend n core inflation? The stabilization started ahead of the Fed’s 50 basis points rate cut on September 18th. The giddy anticipation of that rate cut dominated sentiment. Since then, the market has become relatively more certain about a 25 basis point cut in November.

Long-term bod yields fell going in to the Fed meeting but have since shot nearly straight up. Same for the U.S. dollar. The iShares 20+ Year Treasury Bond ETF (TLT) fell again in response to the CPI report, and the U.S. dollar gained marginally. So the bond and currency markets may start anticipating a longer-lasting stabilization trend. Note how TLT has come straight down except for a one week pause above support at its 50-day moving average (DMA) (the red line below).

Source: TradingView

During this time, the U.S. dollar index (DXY) first bottomed and then shot straight up for much of October.

Source: TradingView

While both shorting bonds and going long the dollar have been profitable trades, the most interesting trading action sits with the S&P 500 (SPY). Despite rising long-term bond yields, the index managed to break out to a fresh all-time high. The September CPI report barely knocked the index off its all-time high. The S&P 500 seems to have a mind of its own and is hardly paying attention to much at all over time. Even the recent increase in the volatility index (VIX) has barely fazed the S&P 500. Moreover, this strengthening bullish appearance is happening during a time which represents the third of the stock market’s most dangerous months.

Source: TradingVIew

In other words, while stabilizing inflation could dampen the trajectory for rate cuts, the S&P 500 seems to be on a near one-way track higher going into the November Presidential elections and year-end. Cause and effect across financial instruments seems quite muted. Or maybe stock traders and investors are straining to make the case that stabilization will soon give way to a resumption of a downtrend in inflation. Either way, it is not clear who is paying attention to stabilizing core inflation.

As long as these broken correlations persist, I prefer to just follow the current trends: fade TLT rallies, buy dips in the U.S. dollar, and, yes, buy the S&P 500 (I am currently hedged with a SPY put spread).

Be careful out there!

Full disclosure: net long the U.S. dollar, long SPY put spread

The post Who Is Paying Attention to Stabilizing Core Inflation? appeared first on Inflation Watch.

This admonition is unsurprising given Macklem’s general reluctance to declare victory over inflation. While the Bank of Canada increasingly sees the elements needed to get inflation back down to 2%, Macklem stated that “we are not there yet.” They need to see sustained and further (for “a number of months”) downward momentum in core inflation.

Cautious About the Signs of Victory Over Inflation

December’s statement on monetary policy also reflected the Bank of Canada’s wavering. The statement estimated that “data and indicators for the fourth quarter suggest the economy is no longer in excess demand. The slowdown in the economy is reducing inflationary pressures in a broadening range of goods and services prices.” These conditions should have generated a declarative victory statement. Instead, the Bank of Canada proceeded to posture staunchly against inflation: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed. Governing Council wants to see further and sustained easing in core inflation, and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

Still, in the interview, Macklem acknowledged that rates are likely to start coming down in 2024. He just refused to provide a timetable.

The Soft Landing

The interviewer pointed out that the scenario Macklem portrays sounds like a “soft landing” for the economy. Macklem was careful not to use that term. Instead he pointed out that much of the adjustment in the labor market has come through a reduction in vacancies instead of a large rise in unemployment. An anticipated weakness in growth for the next 2 to 3 quarters should not generate a “deep” recession. Macklem directly claimed that “we can get inflation back to 2% without a recession.”

This year will be a transition year. By the end of the year, the economy should be in soft landing mode if all goes well.

The Canadian Dollar

The Bank of Canada released its December statement on monetary policy just as the U.S. dollar was experiencing a slight relief rally against the Canadian dollar (USD/CAD) (or the Invesco CurrencyShares Canadian Dollar Trust (FXC)). The slide resumed with the Federal Reserve’s decision on monetary policy the following week and the resulting celebration over the implicit announcement that inflation in the U.S. is dead. I had long anticipated the decline at the time with a target of testing the lower part of a trading range in place since September, 2022.

After taking profits, I am back to accumulating a short position. I expect the Bank of Canada’s on-going caution and the Bank’s refusal to get dovish to act as a tailwind for the Canadian dollar. The chart below from TradingView.com shows volatility in USD/CAD distinctly driven by key events. The Bank of Canada’s next Monetary Policy Report will come on January 24th. The Fed comes around the week after.

So, overall, I continue to favor playing the trading range in USD/CAD as an eventual trip to or toward the bottom of the range. I currently cannot foresee catalysts that will push the currency pair to stray too far away from the range. If USD/CAD escapes the range, I think the odds favor a breakdown over a breakout.

Be careful out there!

Full disclosure: short USD/CAD

The post Bank of Canada’s Macklem: The End is In Sight But Rates Are Not Returning to Pre-Pandemic Levels appeared first on Inflation Watch.