Speaking at the Economic Club of Chicago yesterday, Fed Chair Jerome Powell poured cold water on the stock market’s hopes for a Fed shift towards rate cuts and easier monetary policy.
Powell in fact spoke quite critically of Trump’s tariff policies. In the eyes of many, too critically, given the Fed’s oft-repeated commitment to political neutrality.
Despite clear signs of moderating inflation and risks to growth, Powell expressed concern that the potentially inflationary impact of tariffs is now tying the Fed’s hands and effectively forcing the central bank to hold off on lowering interest rates.
This message was not received well by investors.
Stocks sold off sharply after Powell’s comments, which were interpreted as meaning that Powell had little interest in bailing Trump out with rate cuts.
Powell’s comments were not received well by President Trump either.
In social media posts this morning, Trump declared that “Powell’s termination cannot come fast enough!” Trump also gave Powell a new nickname, “Too Late.”
The idea is that Powell is consistently late in redirecting Fed policy. The most glaring example of Powell’s tardy nature was presumably his failure to raise rates until March 2022, even though inflation began to surge in mid-2021.
Who is right?
The Fed of course has a dual mandate of balancing maximum employment with price stability. So both variables need to be considered.
Trump correctly points out that many leading indicators of inflation, such as the price of oil, have gone down sharply.
In his comments on Wednesday, Powell placed emphasis on the argument that Trump’s tariffs had the potential to cause price shocks. The concern is that imported goods will become considerably more expensive and other trade frictions will drive up final prices.
While these tariff-related price pressures are generally seen as one-time events, Powell indicated he does not want to run the risk that inflation expectations become “unanchored.” As a result, he supports a “wait and see” approach.
Sentiment vs. the bond market
The University of Michigan consumer survey is one of the most widely followed gauges of consumer sentiment and inflation expectations.
In April, the Michigan survey revealed that consumers anticipate inflation in the year ahead to surge to 6.7%, which is the highest reading since 1981. Long-run inflation expectations jumped to 4.4%.
It is not terribly surprising that consumers feel this way. There has been a constant drumbeat in the financial media of economists and other prognosticators as to the likely inflationary impact of tariffs.
Bond prices are telling a very different story, however. Forward inflation expectations have if anything softened in recent months.
The 5-Year Inflation Breakeven represents what the bond market is predicting average inflation rates will be over the next 5 years. It is calculated by comparing inflation-indexed Treasury instruments to standard Treasuries with the same maturity dates.
The 5-Year Inflation Breakeven currently sits around 2.3%. This is only modestly higher than the Fed’s 2% target and a far cry from the Michigan survey data.
