In a recent interview, Fundstrat Co-founder and Head of Research Tom Lee made a convincing but incomplete argument for team non-inflationary when describing the economic impacts of tariffs. From Lee’s perspective, a tariff is a tax that simply reallocates money in the economy. Money transfers from companies and/or consumers in the supply chain to the government. That money goes right back into the economy through government spending. Thus, money just flows from one set of hands to another. This argument seems to rely on a monetary theory of inflation, where an increase in the money supply is the main driver of inflation; tariffs do not increase the money supply.

The Limits of Monetarism in Today’s Economy

Milton Friedman made monetary theory, or monetarism, famous through quotes like: “Inflation is always and everywhere a monetary phenomenon.” Monetarism seemed to work well to explain the economy of the 1970s and 1980s but waned over time according to the IMF. Still, given the fluid and dynamic nature of today’s economies, I am fully willing to accept that monetarism can and will become relevant under the right circumstances. Today’s tariff regime is not creating the right circumstances.

Tariffs, Wages, and Supply Chain Reactions

Because Lee thinks of tariffs as a transfer of money from people and companies to the government, he implied that instead of hiking rates to counteract inflationary effects, the Fed should cut rates in order to counteract a drop in demand from higher prices. However, Lee does not explicitly account for the potential responses to tariffs across the supply chain. As prices rise, consumers may ask for higher wages to cover increased costs in the economy. These higher wages are in turn paid for with higher prices. And so on. Federal Reserve Governor Christopher Waller countered this fear by insisting that today’s economy does not grant workers such economic power, certainly not like they had in the immediate wake of the pandemic. However, as strict immigration policy tightens the U.S. workforce, remaining workers in significant portions of the economy could find themselves with renewed economic power to demand higher wages to offset any real or perceived tariff-driven cost increases. The final or net impacts are hard to predict.

Demand Destruction and Fed Caution

Consumers will find little comfort or relief knowing that their higher costs boost government coffers. For example, the recent budget bill held as a premise that money is better left in consumer pockets and corporate treasuries than in government accounts. Thus, a tariff-induced price hike will induce responses from the payers of that tax in order to offset real economic impacts. In the interview, Lee appears to lean toward demand destruction as the deflationary counterbalance that can relieve pressure on consumers. Yet, with the looming uncertainty about the path of tariff policy and its eventual impacts, the Federal Reserve is well-served to proceed with caution. For example, cutting rates to offset demand destruction could entrench the inflationary impulse that pressured demand. In the optimistic scenario, the Fed could do well to wait on businesses and suppliers to work out efficiencies to avoid passing on tariff costs into the rest of the economy.

The Inflationary Impact Is Real and Already Here

In the middle of all the swirl on inflationary impacts from tariffs comes a recent Federal Reserve study that has already detected inflationary impacts from the current tariff regime and has concluded that the first trade war with China from 2018–2019 also boosted inflation. From “Detecting Tariff Effects on Consumer Prices in Real Time“:

“…we find that US import tariffs led to a statistically significant increase in consumer goods prices. For the 2018–19 tariffs, our local-projections approach reveals that tariff changes were passed through fully and quickly—within two months of tariff implementation—to consumer goods prices. For the February and March 2025 tariffs implemented on imports from China, we find that tariffs have already passed through partially to the consumer goods prices that we can observe through March. Our results indicate that the 2025 tariffs have so far led to a 0.3 percent increase in core goods PCE prices, contributing to a 0.1 percent increase in core PCE prices (goods and services prices, excluding food and energy) as a whole.”

An illustrative research paper from the San Francisco Federal Reserve, “The Effects of Tariffs on Inflation and Production Costs” by Bart Hobijn and Fernanda Nechio, makes an even more stark case for the inflationary impacts of tariffs:

“Estimates suggest that the impact on prices for investment goods is likely to be much larger than for consumption goods. For example, if an across-the-board 25% tariff is fully passed through to finished goods, near-term price increases are estimated to be about 9.5% for investment goods and 2.2% for consumption goods.”

Hobijn and Nechio further explain that “the import content is much larger for investment goods than for consumption goods. This is because domestic markups tend to be smaller for investment goods than for consumer goods, making the import content of their costs much larger.”

Thus, even if aggregate inflation somehow sustains minimal impact because of fortuitous offsets, significant parts of the economy could suffer. Without tariffs, the inflation rates in both periods could have been lower. With inflation still above the Fed’s 2.0% target, a cut in rates in the middle of so much uncertainty carries all types of risks.

Bostic Speaks for Team Inflation

In commentary hearkening back to the warning signs from the last Beige Book, Raphael Bostic, President of the Atlanta Federal Reserve, cautioned in a CNBC International interview that the Fed’s business contacts have clearly signaled their willingness and readiness to raise prices in response to tariffs. In commentary that could be referencing the recent Fed study, Bostic also claimed that inflation is already showing up in current tariffs. Most interesting to me in this inflationary story is Bostic’s counter to the theory posed by Waller and others that tariffs create a one-time price shock and then inflation just goes back to normal (emphasis mine):

“The textbook story for economics is if you do tariffs, it’s a one-time shift. It happens quickly. Everyone understands what’s going on and then the world goes back to how it was before. So you should look through that. What we are seeing today though is not just a one-time shift. It’s actually something that’s being stretched out over a much longer period of time. I think that runs the risk that people start to feel like inflation is always with them. This elevated level of inflation is always with them. And that then runs the risk that there might be some structural changes that businesses and consumers, for that matter, make in terms of how they respond and how they engage in the marketplace.”

Bostic sums up very well why the Fed must proceed with caution. Without clarity on the shape, timing, or magnitude of tariff policy, predictions and models are precarious. Rushing to cut rates risks worsening any upcoming inflation surprises.

Bostic also has support in other economic research. The following quote from an NBER working paper, “Tariffs As Cost-Push Shocks: Implications for Optimal Monetary Policy” by Iván Werning, Guido Lorenzoni, and Veronica Guerrieri, suggests that calls to “see through” tariff shocks represent more economic bravery than some may admit (emphasis mine):

“A widely held tenet in the practice of central banking is that a shock like a tariff shock, that entails a mechanical increase in some prices, is a shock that requires the central bank to “see through it”, in other words, to let the mechanical effect of the tariff in prices to affect the overall price level, but avoid
larger increase in prices. To be fair, this is a rule of thumb which, as far as we know, does not correspond to any result in economic theory.”

Conclusion: Stagflation at the Center

Ultimately, all this back and forth on the potential inflationary impact of tariffs tells me that stagflation remains front and center in the economic window. The Fed is right to remain cautious, but as time drags on, economic risks increase for both inflation from tariffs and for an economic slowdown from demand destruction or even ongoing cyclical factors. Today’s predictions will turn out wrong in surprising ways. The Federal Reserve is caught in a tough position where it needs to wait but may find the rising risks and costs of waiting increasingly difficult to absorb.

The staglfationary risks and dilemmas come through in the following quote from the NBER working paper:

“Is a tariff expansionary or contractionary? The answer depends on how monetary policy responds… Based on our equivalence result, a tariff is best understood as a supply-side disturbance—not a demand-side disturbance—that introduces a trade-off for monetary policy. If the central bank prioritizes price stability, the tariff will lead to a sharp short-run contraction. Alternatively, the central bank can offset this contraction by pursuing an expansionary response. In sum, the notion of a “neutral” monetary policy is not well defined.”

In the meantime, I remain committed to Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP) as my hedge on the Fed’s increasingly precarious stagflationary bind. For now, the ETF has bounced around at the whims of long-term Treasury bonds, vacillating from nervousness over the U.S.’s ballooning debt to reassurances over the economy to mild flight-to-safety flows.

Source: Tradingview.com

Be careful out there!

Full disclosure: long GTIP

Tom Lee’s inflation commentary comes at the 7:25 mark in the video below…

The post Tom Lee Dismisses Tariff Inflation — But Data, Theory, and Research Say Otherwise appeared first on Inflation Watch.

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.

Don’t Come Crying to the Fed Anytime Soon

Bostic definitively stated that the Fed is so determined to press against inflation that it will likely turn a deaf ear to those who will ask for easier monetary conditions the moment the labor market delivers bad news. Emphasis mine:

“You know, as we get further into inflation getting, closer to our target, I’m expecting we’re going to see stresses in labor markets. We’ve not really seen that. And when that starts to happen, people are going to be looking to us to try to do something about that as well, and maybe turn away from our focus on inflation. But we can’t do that, because failing in getting the inflation back to the 2% target will be much more problematic for the economy. And so as people start to call out for action to provide relief in labor markets, I think what we’re going to have to do is just stay laser focused on the fact that, you know, our employment mandate goal, we are very, very close to that right now. And we’re not close to that in inflation. So we have to stay focused on inflation.”

The bad news for the labor market has been long anticipated and stubbornly absent for the people who keep expecting a recession at every turn of the calendar. This “lagging indicator” of economic health just keeps chugging along. Even a recent uptick in initial unemployment claims above 240,000 fizzled out before the “I told you so’s” could drape the economic headlines. The 251,000 in weekly initial claims from January, 2022 stands as the latest high. For now, initial claims continues to tell the same message week after week after week: the Fed has room to hike if inflation remains an issue. Rate cuts are certainly nowhere on the horizon from this vantage point.

Source: U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; May 25, 2023.

Given this data and Bostic’s determination to ignore anyone who wants the Fed to cut rates into an inflationary environment, I understand Bostic’s best guess target for rate cuts set a year or more out from now.

“My best case is that we won’t be thinking about a cut until well into 2024. And, you know, inflation is just double what our target is by just about every measure. I don’t see scenarios where the economy is going to evolve in a way such that inflation gets close enough to our target where we might contemplate any kind of cut.”

As of the time of writing, Fed fund futures have acquiesced to the likelihood of another rate hike by July. However, they still eagerly anticipate rate cuts as soon as November. By the time Bostic guesses the Fed will think about cuts, the futures think the Fed will have 6 or 7 rate cuts in the books. The persistently wide gulf between Fed and market expectations on rate policy remains one of the more remarkable features of today’s financial markets.

Fresh Wind for the U.S. Dollar

The market’s push for another rate hike by July has helped the U.S. dollar regain momentum. Strength particularly against the euro and the Japanese yen has the dollar index (DXY) bouncing off its lows for the year. I am riding this momentum as long as it holds up. If the rally continues from here, I expect fresh resistance at the year’s high which should also coincide at the time with critical resistance from the 200-day moving average (DMA) (the bluish line below).

Source: TradingView.com

Be careful out there!

Full disclosure: net long the U.S. dollar

The post Fed’s Bostic: Still Comfortable Leaning Into Tight Labor Markets appeared first on Inflation Watch.