The Fed needs to be on guard for potential inflation from tariffs, says Roger Ferguson

Key Concepts

• Transitory Inflation
• Tariffs and their impact on inflation
• Nearshoring and supply chain restructuring
• Disinflationary forces
• The Fed's 2% inflation target
• University of Michigan (Umich) survey as an outlier
• SEP (Summary of Economic Projections) and dot plots
• Restrictive vs. balanced monetary policy
• The Fed's dual mandate (price stability and maximum employment)

Inflation and Tariffs

• Powell's Use of "Transitory": Roger Ferguson expresses surprise at Jerome Powell's use of the term "transitory" again, given its history. He suggests Powell could have said the Fed would be watching the impact of tariffs closely and prepared to act to ensure any potential inflationary impact is transitory.
• Risk of Persistent Inflation: Ferguson believes there's a real risk that inflation following tariffs could be more persistent than anticipated. This is due to the potential redoing of supply chains and the fact that inflation, while coming down, is still not at the Fed's 2% target.
• Inflation Expectations: Some market measures and surveys show inflation expectations are elevated or moving in the wrong direction, adding to the concern.
• Context Matters: The context of existing inflation and inflation expectations is crucial when assessing the potential impact of tariffs.
• Fed's Need to Be on Guard: Ferguson argues that the Fed needs to be prepared for the possibility that tariffs, if implemented and sustained, could create inflation that is difficult to remove from the system.

Nearshoring and Structural Inflation

• Nearshoring Encouragement: Tariffs further encourage companies to engage in nearshoring, potentially leading to structural changes in the economy.
• Era of Structurally Higher Inflation?: Ferguson expresses concern that we may be entering an era of structurally higher inflation, prompting investors to rethink the 2% target.
• Disinflationary Forces Waning: The disinflationary forces that have driven the global economy for the last 20 years, such as the integration of Chinese workers into the manufacturing system, are likely behind us.
• Increased Spending: Increased spending on areas like defense and the restructuring of supply chains (nearshoring) contribute to potential inflationary pressures.
• Prepared for a Different World: Ferguson suggests we might need to be prepared for a different economic environment than what we've experienced in recent decades.

Data and the Fed's Response

• Umich Survey as an Outlier: Powell's tone regarding the University of Michigan survey, which showed different results compared to past data, was almost dismissive, labeling it an outlier.
• Soft Data vs. Hard Data: The discussion touches on when the Fed starts incorporating "soft data" into its decision-making, alongside "hard data."
• SEP and Dot Plots: The SEP (Summary of Economic Projections) and the "dot plots" (individual Fed officials' interest rate projections) indicate that the number of Fed officials expecting either 0 or 1 rate cut (not two) doubled from 4 to 8.
• Tariffs Factored into Forecasts: Powell has acknowledged that people are starting to factor tariffs into their inflation forecasts.
• Hard Data Not Showing Slowdown: So far, hard data has not suggested a slowdown in the economy.
• Fed's Forecasts: The Fed's own forecasts show an increase in the unemployment rate and a much lower growth rate.
• Fed Already Thinking About Impacts: Ferguson believes the SEP indicates that the Fed is already considering both the inflationary impact of tariffs and the potential slowdown as consumers and businesses adjust.

Monetary Policy and the Fed's Position

• Past Jawboning: A reference is made to past instances where President Trump pressured Jay Powell to lower rates.
• Potential Damping Effect: The discussion considers the possibility that a damping effect on the economy, combined with tariffs and potential inflation, might make the Fed's current stance restrictive.
• Ten-Year Yield Signal: The ten-year Treasury yield seems to be suggesting that the Fed's policy is restrictive.
• Fed Prepared to Cut: Powell has stated that the Fed is prepared to cut rates if the data warrants it.
• Avoiding the Appearance of Being Bullied: The Fed doesn't want to appear to be influenced by external pressures, including the President.
• Attuned to Dual Mandate: The Fed is attuned to both parts of its dual mandate: price stability and maximum employment.
• Balancing Act: The Fed is in a difficult position, expecting higher inflation and slower growth, requiring a balancing act. They are currently in a waiting mode.

Synthesis/Conclusion

The interview highlights concerns about the potential for tariffs to lead to persistent inflation, especially in the context of changing global economic forces. While the Fed is currently in a "wait and see" mode, it is acknowledged that they are considering the potential impacts of tariffs and a possible economic slowdown. The Fed faces a challenging balancing act in managing its dual mandate of price stability and maximum employment in this uncertain environment. The discussion emphasizes the need to monitor both hard and soft data to assess the true impact of these factors on the economy.