Cloudy with a chance of stagflation

Politico

5 days ago

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Quick Fix
Economic analysis these days has the feel of every trailer you've seen where someone ominously proclaims that a storm is coming.
A tariff tornado is headed for the U.S. economy, and Federal Reserve officials can see it coming, but they don't know which way it will swerve or how much damage it will cause.
A federal court ruling on Wednesday evening threw a further wrench into the equation, striking down President Donald Trump's 'reciprocal' tariffs on a wide range of countries, saying his effort to justify them with broad claims of national emergencies exceeded his legal authority.
The Justice Department moved swiftly to appeal the decision, so the question is far from settled, like most everything on tariffs. And it's safe to say that Trump will still look for ways to put taxes on imports (notably, the ruling doesn't touch sectoral levies on products like steel and autos, which were imposed under a different law).
To find out how this movie turns out, you'll have to stay through the end.
For now, the sun is still shining, with inflation cooling close to 2 percent and unemployment near 4 percent. But how might this play out?
That question has preoccupied economists, begun to chill business activity and kept the Fed in a holding pattern as policymakers watch for fallout, beyond the 'downbeat' sentiment among manufacturers and retailers that they discussed at their rate-setting meeting earlier this month.
The earliest tariff effects have cropped up in the form of lower profit margins for producers, as well as higher prices for furniture. 'If you're looking for a specific month where I would expect to see a lot more of it come through [in the Consumer Price Index], it's the June data that comes out in the middle of July,' said Omair Sharif, president of Inflation Insights.
Prices could continue to climb heading into the fall, as companies get a better idea of where tariff rates will ultimately land. For the time being, Sharif noted that some retailers have been selling goods at a discount in the hopes of unloading the pre-tariff inventory they built up before the economy weakens enough to slow sales.
But it might be the higher prices themselves that really spur the hit to growth by eating into consumer spending, a dynamic that could stay the Fed's hand on rate cuts until late in the year. That is, Chair Jerome Powell won't want to ease off inflation until he's certain the economy needs the help.
'The progression is both very important and very uncertain,' said Jason Furman, a Harvard professor who served as President Barack Obama's top economist. 'If inflation comes first, even if it's understood that it's because of tariffs, I think it will raise the bar on rate cuts, in terms of the job loss you need to see.'
As a result, investors are increasingly expecting the central bank to stand pat until September or October, according to CME's FedWatch tool.
The problem, KPMG chief economist Diane Swonk told MM, is that heading off stagflation — when higher unemployment and higher inflation happen simultaneously — requires the Fed to wait for pain.
'Everyone talks about the danger that the Fed is going to be too late,' she said. 'The mistake the Fed is hedging against is stagflation, and when you're hedging against stagflation, by design, you have to be too late.'
'If they're too soon, the consequences of that are much greater than if they're too late,' she added.
Minneapolis Fed President Neel Kashkari told Bloomberg TV this week that he's not sure if the tariff picture will be clear by September.
'We will have to see what the data says, but also how the negotiations are going,' he said. Trade deals over the next few months 'should provide a lot of the clarity we are looking for,' he added.
Meanwhile, all of those factors could come to a head just as the Trump administration begins in earnest to consider who should replace Powell when his term as chair ends next May.
'All those decisions are going to spark and intensify Trump's pressure on the Fed, and in addition, he could use it as an example of why he needs to find somebody who is, most important from his perspective, loyal to Trump,' said Sarah Binder, a professor at George Washington University. 'That search is going to take place at a time when the Fed is not out of the woods, given all these economic pressures.'
IT'S THURSDAY — What's your favorite barometer of economic activity? Let me know: [e-mail].
And as always, send your tips, suggestions and personnel moves to Sam at [e-mail].
Driving the day
The second estimate for first-quarter gross domestic product is out at 8:30 a.m. … Richmond Fed President Thomas Barkin participates in a fireside chat before the Housing Partnership Network at 8:30 a.m. … Chicago Fed President Austan Goolsbee speaks at the 2025 Mackinac Policy Conference hosted by the Detroit Regional Chamber at 10:40 a.m. … Fed Gov. Adriana Kugler speaks at the central bank's Macro-Finance Workshop at 2 p.m. … San Francisco Fed President Mary Daly speaks at the Oakland Rotary Club at 4 p.m. … Dallas Fed President Lorie Logan speaks at the Greater Waco Member Appreciation event at 8:25 p.m …
Elon bows out — 'As my scheduled time as a Special Government Employee comes to an end, I would like to thank President @realDonaldTrump for the opportunity to reduce wasteful spending,' DOGE head Elon Musk posted on X. 'The @DOGE mission will only strengthen over time as it becomes a way of life throughout the government.'
Musk's off-boarding was set to begin Wednesday night, a White House official told ABC News.
— The White House plans to send a small package to formalize some DOGE spending cuts to Congress next week, senior GOP officials told several House Republicans on Wednesday, our Meredith Lee Hill and Jennifer Scholtes report. Two senior administration officials also confirmed the plan.
Where Dems split on Trump — Fighting the president has long been a unifying cause for Democrats on Capitol Hill, but a clash over stablecoin legislation is starting to expose fissures in the resistance, our Jasper Goodman reports.
Sen. Chris Murphy (D-Conn.) has called for Democrats to make Trump's 'corruption and the destruction of democracy the No. 1 issue.' But some Democrats want to forge ahead with legislation on crypto.
— Related reading: Trump's pro-crypto agenda is increasingly intertwined with his financial interests, our Jake Traylor, Declan Harty and Irie Sentner report.
Big beautiful blowback — Industry groups representing fintechs, payment businesses and banks are dialing up their public opposition to a politically thorny provision of the House's tax package: a new 3.5 percent tax on foreign remittances sent by non-U.S. citizens, Sam reports.
Many Wall Street and financial industry groups have refrained from airing their specific grievances with Trump's legislative agenda, but the American Fintech Council's letter suggests that opposition to major components of the bill will grow in the coming weeks as Senate lawmakers plan substantial revisions to the legislation.
Trade War
Tariff fallout — General Motors CEO Mary Barra defended Trump's tariff regime at The WSJ's 'Future of Everything' event. 'For decades now, it has not been a level playing field for us automakers globally, with either tariffs or non-tariff trade barriers. So I think tariffs is one tool that the administration can use to level the playing field,' Barra said.
— Nearly two-thirds of the chief executives polled by PwC in the consulting firm's latest pulse survey said they're renegotiating pricing with suppliers, and 60 percent said they're passing tariff-related costs to consumers or plan to do so, according to results shared with MM.
— Still, a separate poll of small business owners taken in April by the Capital One Insights Center, shown exclusively to MM, found that 89 percent of small businesses are optimistic that their businesses will grow. Roughly half of those surveyed said the previous year was the most difficult they faced as business owners.
TACO Wednesday — Trump bristled when asked about the acronym TACO, which stands for 'Trump always chickens out,' that's been adopted on Wall Street. It relates to bets to take advantage of the trade environment created by the president's habit of threatening to impose tariffs on countries, and then backing off at the last moment, our Ali Bianco reports. 'To me, that's the nastiest question,' he said.
At the regulators
Fed nixes climate groups — The Fed has disbanded a number of internal groups that were intended to help the central bank identify and respond to financial stability threats posed by climate change, Bloomberg News reports.
Trump: U.S. would still back privatized housing finance giants — Trump has pledged to preserve Fannie Mae and Freddie Mac's implicit guarantee of government support as he works to take the two mortgage-finance giants public, though the administration's top housing regulator offered few details Wednesday on what the process of ending conservatorship would look like, our Katy O'Donnell reports.
A national battle over personalized pricing — In California, Georgia, Illinois, Colorado and New York, state lawmakers have introduced bills to set rules around 'surveillance pricing,' a growing practice that worries consumer advocates due to potential unfairness and use of sensitive information, but they're running into corporate pushback, our Alfred Ng reports.
CRYPTO CORNER
Not quite Crypto USA — Bitcoin may be surging, the president may be a crypto bull, and the industry may be getting its way on Capitol Hill. But the adoption of crypto is not exactly exploding in the U.S., Declan reports. The Federal Reserve's latest economic well-being household survey found that just 8 percent of Americans used crypto in 2024, a slight uptick from 7 percent in 2023, though far from the 12 percent that was recorded in 2021.
Crypto in your 401(k)? — The Labor Department on Wednesday yanked Biden-era guidance that strongly discouraged employers from offering cryptocurrency in workers' 401(k) plan options, which Secretary Lori Chavez-DeRemer called an attempt by the previous administration 'to put their thumb on the scale' against cryptocurrency investments, our Nick Niedzwiadek reports.