Extreme uncertainty about the outcome of U.S. tariff negotiations and trade policies’ ultimate effects on inflation and growth will make it hard for Federal Reserve officials to justify interest rates cuts soon, former Chicago Fed President Charles Evans told MNI.
It's likely that “this stalls inflation improvement, and it puts them in the unhelpful situation where for a period of time inflation is going to go up,” Evans said in an interview.
Even though the relative hit to prices from tariffs could be a one-time shock, policymakers might be reluctant to count on that because they were burned by the transitory label before – when Covid-era inflation surged to 40-year highs.
“It's just injected all kinds of uncertainty as to what the level of tariffs will be, because it's joined with, presumably, a negotiating strategy with countries. So you've got higher relative prices for many goods, and you've got the added uncertainty of you don't know how long that's going to last,” he said.
Evans agrees with FOMC officials who have argued recently the Fed is “well-positioned” to react to either an instance where inflation rises or proves more intractable or, conversely, a scenario where tariff chaos overwhelms the expansion and causes it to sputter.
“They've got a restrictive setting of the funds rate at 4.3% and – this is not the scenario that they envision – but if they had to worry about higher inflation pressures and unanchored inflation expectations, they are better positioned and closer to moving to an appropriately restrictive stance.”
Before tariffs entered the picture, Fed officials had been successfully guiding inflation gradually back to the central bank’s 2% target without causing a recession, which Evans said was a remarkable achievement. Now, the prospect of a soft landing seems to have all but evaporated.
Fed officials are likely hoping the inflationary effects of tariffs will be temporary but can’t count on it, especially after the Covid episode, said Evans. That creates the need for an ongoing anti-inflation bias that raises the bar for additional monetary easing, he said.
“The commitment to 2%, how does that interact with the normal thinking about dual mandate, trade-offs, if you feel like your reputation and the anchoring of inflation expectations means you have to really put more weight on inflation going up,” he said. “You've got to hope it's transitory but we hoped it was transitory in 2021. So it takes a lot of steely resolve to make those decisions.”
By the same token, if the economy were showing real signs of fraying, then the Fed would probably ease more aggressively than markets are currently pricing in.
“Markets are looking at three cuts, five cuts, depending on how you look at it. That still only takes you to 3.5%, 3.25% or 3%. The Fed has said that 3% is neutral and if you’re really working against a downturn you expect neutral is not exactly were you’d want to be,” said Evans.
“On the other hand, with inflationary pressure – there’s so many things to work through. How they end up putting weights on each aspect of that. They still have to see more data.”