Fed governors Bowman, Waller explain their dissents, say waiting to cut rates threatens economy

Key Concepts

• Dissenting Fed Governors: Waller and Bowman disagreeing with the majority decision.
• Tariffs as One-Off Price Increases: The argument that tariffs cause a temporary price level effect, not sustained inflation.
• Neutral Monetary Policy: A policy stance that is neither stimulating nor restricting economic growth.
• Fragility in Labor Markets: Signs of weakening job growth and potential for increased unemployment.
• PCE Inflation: Personal Consumption Expenditures inflation, a key measure of inflation for the Fed.
• Tariff Absorption: The idea that various entities in the supply chain (exporters, importers, retailers) or currency fluctuations can absorb the cost of tariffs.

Fed Governors' Dissent

Governors Waller and Bowman dissented at the recent Fed meeting, advocating for a quarter-point rate cut. They explained their reasoning on the Friday following the meeting, continuing a tradition of public explanation.

• Waller's Argument: Waller argued that tariffs are "one-off price increases" and should not be considered as causing sustained inflation. He cited standard central banking practice to "look through price level effects." He pointed to a GDP of 1.2% and expectations of softer growth for the rest of the year, suggesting monetary policy should be close to neutral, not restrictive. He believes inflation is close to the target if tariff effects are put aside. He also noted that payroll growth is "near stall speed" and there's downside risk to the labor market, arguing that the Fed shouldn't wait for the labor market to deteriorate before acting.
• Bowman's Argument: Bowman echoed Waller's sentiments, stating that inflation has moved considerably closer to the target after excluding the temporary effects of tariffs. She noted that economic growth has slowed markedly, and labor markets are showing increasing signs of fragility. She believes a neutral policy setting is appropriate and that a rate cut would have hedged against potential weakness. She also stated that if you take out the tariff effect, we're at 2.5% or lower PCE inflation.

Tariffs and Inflation

The discussion revolves around whether the Fed should "look through" the inflationary effects of tariffs, considering them temporary.

• Tariff Inflation Calculation: The governors are calculating inflation excluding the effects of tariffs.
• Exporters Eating Tariffs: There's a suggestion that exporters might be absorbing some of the tariff costs, which would align with the ideal scenario where the exporting countries are effectively paying the tariffs.
• CFO Council Insights: A CFO Council meeting revealed concerns about whether suppliers and distributors have enough margin to absorb the tariffs. One CFO questioned whether their suppliers had 15% of extra margin to give.
• Margin Impact: The impact of tariffs on margins depends on the markup structure. While a 15% tariff on a $3 item sold for $25 might not be a big deal for high-margin retailers, it can significantly impact businesses with low margins, like grocery stores (1-2% margins).
• Supply Chain Absorption: The point is made that tariffs can be absorbed at various points in the supply chain: the exporter, the importer, and the retailer. Currency fluctuations can also play a role.

Labor Market Weakness

Both governors highlighted the increasing signs of fragility in the labor market as a reason for considering a rate cut.

• Payroll Growth Near Stall Speed: Waller specifically mentioned that payroll growth is near stall speed, indicating a slowdown in job creation.
• Downside Risk: Both governors acknowledged the downside risk to the labor market, suggesting a potential for further deterioration.

PCE Inflation and Tariff Impact

Bowman's comments provide a specific estimate of the impact of tariffs on inflation.

• 2.5% or Lower PCE Inflation: Bowman stated that excluding the tariff effect, PCE inflation is at 2.5% or lower.
• 0.3 Percentage Point Impact: This implies that tariffs are currently contributing approximately 0.3 percentage points to PCE inflation.

Conclusion

The discussion highlights a division within the Fed regarding the appropriate response to the current economic situation. Governors Waller and Bowman argue for a rate cut, citing concerns about slowing growth, a weakening labor market, and the belief that the inflationary effects of tariffs are temporary. Their dissent underscores the complexity of the economic outlook and the challenges facing the Fed in setting monetary policy. The key takeaway is the debate over whether the Fed should "look through" tariff-related inflation and the extent to which the labor market is showing signs of weakness.