Tariff effects are going to show up in next month's CPI data, says Morgan Stanley's Ellen Zentner

Key Concepts:

• Core Inflation: Inflation excluding volatile food and energy prices.
• Headline Inflation: Overall inflation rate including food and energy prices.
• Wait-and-See Posture: A monetary policy approach where the central bank observes economic data before making decisions.
• Tariff Effects: The impact of tariffs on prices and economic activity.
• Slack in the Labor Market: The availability of unemployed or underemployed workers.
• Term Premium: The extra yield investors demand for holding long-term bonds compared to short-term bonds.
• Easing vs. Cutting: Easing implies stimulating the economy, while cutting may simply adjust to slower growth.
• Reconciliation Bill: A legislative process to expedite budget-related legislation.
• Private Final Domestic Demand: Measures the total value of goods and services purchased within a country's borders by individuals, businesses, and non-profit organizations.

Inflation and Interest Rate Outlook

• Current Inflation: Core inflation is hovering around 2.8%, showing little movement towards the Fed's 2% target. Headline inflation has shown some improvement.
• Roger Ferguson's Perspective: Supports a "wait-and-see" approach, emphasizing that core inflation needs to show more progress towards 2% before considering rate cuts. He acknowledges the logic behind potential cuts but remains unconvinced based on current data.
• Ellen Zentner's Perspective: Believes tariff effects will impact next month's inflation data. She anticipates the Fed will cut rates this year due to slowing growth (around 1%) and increasing slack in the labor market. She suggests the Fed might view tariff-related inflation as a "one-off level shift" and look beyond it.
• Potential for Rate Cuts: Zentner argues that slowing growth will create more slack in the labor market, making it easier for the Fed to cut rates. She points to declining tourism numbers as evidence of a weakening economy.
• Timing of Cuts: The Fed is unlikely to cut rates immediately due to the need for consensus within the committee. Cuts are more likely when unemployment rises and growth clearly slows.
• Easing vs. Cutting Distinction: The Fed may frame rate cuts as an adjustment to slower growth rather than a stimulus measure.

Economic Growth and Uncertainty

• Growth Slowdown: The U.S. economy is expected to slow to around 1% growth this year, down from 3% last year.
• Volatility in Demand: The first half of the year is expected to be volatile due to a pull-forward of demand in the first quarter, potentially leading to flat or negative demand in the second quarter.
• Impact of Tariffs: Tariffs are contributing to economic uncertainty and potentially impacting tourism and overall demand.

Fiscal Policy and the Deficit

• Deficit Size: The deficit is projected to be large, potentially around $4 trillion this year.
• Tax Bill Impact: The tax bill is expected to add $4 trillion or more to the deficit over ten years.
• Term Premium: The large deficit contributes to a higher term premium, as investors demand more compensation for holding long-term bonds.
• Potential Implications for Monetary Policy: The large deficit raises questions about whether the Fed should cut rates, as lower rates could enable more fiscal spending.

Notable Quotes:

• Roger Ferguson: "The core inflation number has moved sideways at 2.82.8. That's not exactly moving directly towards two...the wait and see posture at this stage is still merited."
• Ellen Zentner: "This number doesn't matter because the tariff effects are going to really start to show up in next month, number."
• Ellen Zentner: "We're not easing, we're not cutting to stimulate the economy. Just the economy has slowed dramatically this year, and we don't need to have rates this high. So it won't be easing. It'll just be cutting."

Technical Terms:

• Core Inflation: A measure of inflation that excludes volatile items like food and energy to provide a more stable view of underlying price pressures.
• Headline Inflation: The total inflation rate, including all items in the consumer price index (CPI).
• Term Premium: The difference in yield between a long-term bond and a short-term bond, reflecting the extra compensation investors demand for the risk of holding longer-term debt.

Logical Connections:

The discussion flows from the current inflation data to the potential Fed response, considering factors like economic growth, the labor market, and fiscal policy. The speakers debate the likelihood and timing of rate cuts, weighing the risks of cutting too soon versus waiting too long. The conversation also explores the interplay between monetary and fiscal policy, particularly the impact of the large deficit on interest rates.

Synthesis/Conclusion:

The experts present differing views on the Fed's likely course of action. While Zentner anticipates rate cuts due to slowing growth and a softening labor market, Ferguson advocates for a more cautious "wait-and-see" approach, emphasizing the need for further progress on inflation. The discussion highlights the complexities facing the Fed, balancing the risks of inflation and recession in an environment of economic uncertainty and large fiscal deficits. The key takeaway is that the Fed's decisions will be data-dependent and influenced by a range of economic factors.