Waller’s Case: Tariff-Driven Inflation Is Transitory

Just two days after Federal Reserve Chair Jerome Powell insisted that meaningful inflation is coming, Fed Governor Christopher J. Waller shared a nearly polar opposite narrative. Of course, given Waller may be on the short list of the President’s next pick to head the Federal Reserve, he has a built-in motivation to speak with authority in support of the administration’s claims that tariffs are not a threat to inflation. During a CNBC interview, Waller made the case for transitory and immaterial inflationary impacts from tariffs that would allow the Fed to start cutting rates as early as the July meeting. Waller explained that the Fed had paused for six months fearing inflationary impacts from tariffs that have yet to materialize. He chose to look through the ongoing uncertainty on tariff levels, timing, and frequency of change, as well as the recent Beige Book, which was full of accounts of businesses preparing for or already responding to tariff risks. Moreover, Waller claimed that only about 10% of the price index comes from imports (which made me wonder why there is any fuss over tariffs!). Instead, Waller expressed greater concern about the potential economic weakness caused by tariffs and stated he does not want to wait to cut until “we see a crash.”

Waller also referred to a speech he gave in South Korea in early June that laid out the detailed economic case for looking through tariffs as a one-time price shock. In “The Effects of Tariffs on the Three I’s: Inflation, Inflation Persistence, and Inflation Expectations,” Waller concluded that “the economics behind a tariff increase implies it should have a transitory effect on prices—tariffs raise prices once, but those prices don’t keep going up.” This conclusion holds if tariffs are hiked all at once in a one-and-done fashion. Otherwise, this reassurance reinforces the same argument Treasury Secretary Bessent made at the beginning of the tariff drama, trauma, and noise. Assuming that long-term inflation expectations remain anchored (as they are in market-based measures and professional forecasters, not in consumer-level surveys), Waller concluded “the tariff-induced inflation will be transitory and [the Fed] should look through it when setting policy.”

Powell’s Caution: Don’t Rush the Cuts

When Powell appeared on June 24th in front of the House committee to deliver the semiannual monetary policy report before the House Financial Services Committee, he was, of course, peppered with questions about tariffs and inflation. At one juncture, Powell took the opportunity to agree with Waller with an important condition (emphasis mine): “I do agree that basically if things are a one-time increase, then you don’t respond to them. That’s the whole idea if there’s a shock to prices… generally speaking you don’t respond if you are highly confident that it will just be a one-time shock.” Powell went on to caution that this particular situation is “a complicated one,” and said the Fed must make this decision about the timing of rate cuts “with some care.” He added that the Fed has not yet reached a point of price stability, and these large tariffs “raise kind of more concern” given the economy is just a few years out from a highly inflationary environment.

Powell’s caution appears warranted. Attempts to pattern-match to past history are challenging because of the scale and magnitude of the potential tariffs. The volatile implementation of economic policy means the Fed cannot be sure that tariff hikes will be a one-time episode. So, while a coming price shock may move inflation away from target, there remains some uncertainty about whether the Fed will be able to watch inflation settle back to target.

Bowman and Daly Lend Conditional Support

Vice Chair for Supervision Michelle W. Bowman added commentary on monetary policy in a speech the day before Powell’s testimony: “Assessing the Effectiveness of Monetary Policy During and After the COVID-19 Pandemic,” at a research conference sponsored by the International Journal of Central Banking and the Czech National Bank in Prague, Czech Republic. Bowman positioned herself as supportive of imminent rate cuts, although she did not specifically target July. Instead, she outlined broad conditions supportive of rate cuts: “If inflation remains near its current level or continues to move closer to our target, or if the data show signs of weakening in labor market conditions, it would be appropriate to consider lowering the policy rate, moving it closer to a neutral setting.” Bowman shared Waller’s concerns for the economy and stated that inflation appears on a sustained downward path to the 2% target:

“As we think about the path forward, it is time to consider adjusting the policy rate… we should recognize that inflation appears to be on a sustained path toward 2 percent and that there will likely be only minimal impacts on overall core PCE inflation from changes to trade policy. We should also recognize that downside risks to our employment mandate could soon become more salient, given recent softness in spending and signs of fragility in the labor market.”

Bowman expressed reassurance in the lack of inflationary impact from tariffs to date: “It appears that any upward pressure from higher tariffs on goods prices is being offset by other factors and that the underlying trend in core PCE inflation is moving much closer to our 2 percent target than is currently apparent in the data.” While acknowledging some upside risks for inflation, Bowman emphasized that she is “not yet seeing a major concern, as some retailers seem unwilling to raise prices for essentials due to high price sensitivity among low-income consumers and as supply chains appear to be largely unaffected so far.”

On Bloomberg Surveillance, June 26, Federal Reserve Bank of San Francisco President Mary Daly capped the dovish commentary by leaning toward the third of three timing scenarios for inflation:

1. Delayed, tariffs will have some impact and will be more persistent.
2. Delayed but will be one-off.
3. Does not deliver the punch history suggests will come as businesses absorb costs.

Daly stated that her “modal expectation” had been for some time that the Fed would be ready to cut rates in the fall. Thus her current dovishness is consistent with prior stances. Daly acknowledged tariffs “will potentially raise inflation.” However, since the impact should dissipate over time, it should not build into inflation expectations.

Rate Cuts, Politics, and the Fed’s Legacy

As the Fed’s debate about the impact of tariffs on inflation plays out, I am reminded that there is a larger context that influences how the Fed positions itself. The Federal Reserve was slow to respond to inflation in the throes of the pandemic, assuming that the price shock would be “transitory.” Even though he brought back the term “transitory,” even Waller revealed, “I am willing to admit that, at the time, I underappreciated how the large and sustained fiscal response would combine with highly accommodative monetary policy to overstimulate aggregate demand in an economy that quickly recovered from the early effects of the pandemic.” Waller is full steam ahead on team transitory again, while Powell continues to act like someone who still feels the scars. Powell’s caution makes even more sense in this context.

While Powell insists he is ignoring the political noise about his competence, his unwillingness to follow Presidential orders, and public ruminations about his firing or the looming presence of a shadow Fed Chair, Powell’s adamant stance sure has the appearance of someone trying to prove a point of toughness and independence. Thus, I fully expect Powell to be the “last one” to reluctantly move forward with rate cuts. I even expect his messaging at the time of the first rate cut to place responsibility squarely on the broader Fed… and to include some residual hawkishness of his own.

Overall, I lean toward Powell’s caution for all the reasons he gave to Congress. The environment remains highly uncertain, and the Fed has not yet reached its price target, even as a large price shock looms. Cutting rates in the midst of this swirling dynamic would signal a high degree of confidence in the post-shock equilibrium. Moreover, the Fed may have fundamentally different reads on the economy. For example, Daly insisted that “there are no warning signs that the economy is weakening, although progressing more slowly than before.” So if the Fed is both hampered by lower-quality data (due to federal budget cuts) and divided on the economy’s health, proceeding with rate cuts sooner rather than later seems doubly risky.

Conclusion

I will be highly surprised by a July price cut. Indeed, the CME FedWatch tool shows just a 21% chance of a cut, while September’s meeting has a 96% chance. These high odds essentially lock the Fed into cutting rates at the September meeting in order to avoid shocking the market. The messaging around that rate cut will be critical. Moreover, will the bond market get spooked and send long-term rates higher, just as it did both times the Fed cut rates last year?

The volatility index (VIX) sure looks incredibly low given the potential fireworks ahead. After breaking support from the dawn of the tariff drama, trauma, and noise, the VIX started this week right on top of that line.

Be careful out there!

Full disclosure: no positions

The post Powell vs. Waller: Divided Fed Faces Tariff-Driven Inflation Uncertainty appeared first on Inflation Watch.

• 2025 GDP growth at 1.5-1.9% (down from 1.8-2.2% in December)
• PCE inflation at 2.6-2.9% (up from 2.3-2.6%)
• Federal funds rate at 3.9-4.4% (up from 3.6-4.1%). These adjustments allow for minimal rate cuts this year, preserving flexibility.

Despite rising near-term inflation expectations, Powell reiterated, “We do not need to be in a hurry to adjust our policy stance and we are well positioned to wait for greater clarity.” This approach sought to reassure jittery financial markets while preserving optionality, a critical balancing act as economic chaos and uncertainty intensifies. Specifically, Powell coolly presented two potential scenarios, supposedly neither of which will trip up the Fed:

“If the economy remains strong and inflation does not continue to move sustainably toward 2% we can maintain policy restraint for longer. If the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated we can ease policy accordingly. Our current policy stance is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.”

Powell further argued that inflation expectations – while rising in the short term – are not shifting over the long run:

“We do see increases widely in short-term inflation expectations and people who fill out surveys and answer questionnaires are pointing to tariffs about that. If you look in the survey world, if you look a little further out, you really don’t see much in the way of an increase. Longer-term inflation expectations are mostly well anchored.”

Powell used this argument to suggest that short-term inflationary pressures, including tariffs, should not be mistaken for a structural return to high inflation. By insisting that long-term inflation expectations remain stable, Powell steered the conversation away from stagflation and toward a more benign interpretation of recent inflation trends.

However, Powell extended these reassurances too far by parroting Treasury Secretary Bessent’s claims that tariffs are a one-time and transitory inflationary impact. Powell insisted 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, if it’s transitory…and that can be the case in the case of tariff inflation.” I critiqued this explanation in “The Sleight of Hand Behind the ‘One-Time Adjustment’ and ‘Transitory’ Tariff Inflation Narrative“. While a tariff can impose a one-time price adjustment, that adjustment embeds higher costs into the economy. Powell himself acknowledged that consumers remain deeply frustrated by elevated price levels, stating, “The grocery bill is about past inflation really…they’re unhappy and and they’re not wrong to be unhappy that prices went up quite a bit and they’re paying a lot for those things.” It is exactly the higher price level that formed the core of my critique of dismissing tariffs as transitory. This deft maneuver worked in the moment as no one in the press pushed back and pointed to elevated price levels as being the future concern for tariffs now.

Powell also created uncertainty about the ultimate inflationary impact of tariffs: “we also hear that people are very reluctant to allow prices to go up. At the same time we hear that businesses are intending to pass many of these prices through. So it’s hard to say how this is going to work out.” Given this uncertainty, Powell should not suggest or even hint that tariff-driven inflation could be transitory. After all, the transitory framework failed miserably in 2021.

The market reaction to Powell’s messaging will be crucial in the coming weeks. Will Powell’s deft maneuvering and lack of urgency be sufficient enough to inoculate financial markets against the on-going, surrounding policy and economic chaos of rising inflation expectations, tariff-driven uncertainty, and fragile consumer sentiment? Powell’s ability to maintain flexibility will be tested as market participants digest his messaging. The next few weeks could determine whether his balanced stance reassures investors or leaves them scrambling for clarity all over again. For now, the immediate reaction in the stock market signaled a spark of relief.

The below 15-minute chart of the S&P 500 (SPY) provides the critical price levels traders need to watch in coming days for support and resistance during this bear market. Buyers celebrated with relief upon the release of the statement but ran out of gas at the intraday high of the week as Powell concluded the Q&A with reporters.

Conclusion

Powell successfully maneuvered what could have been a challenging press conference without committing the Fed to a firm policy shift. While he downplayed stagflationary risks and sidestepped concerns about persistently high price levels, worsening economic realities could eventually force Powell and the Fed to recalibrate this strategy under far more difficult market conditions.

Be careful out there!

Full disclosure: long SPY

Note: this post was edited with the help of ChatGPT 4.0

The post Jerome Powell’s Fed Deftly Maneuvers Through a Stagflationary Minefield 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.