The latest Consumer Price Index (CPI) report was released on Wednesday morning, with inflation once again coming in below expectations for the fourth straight month. Core CPI, which strips out food and energy, rose just 0.1% month over month and 2.8% year over year. Overall CPI came in at 2.4%, which matched or came in below some estimates.
While most prices were stable or declined, prices for toys jumped the most since 2023, and appliances posted their largest price hike in nearly five years. Those two categories are among the most exposed to Chinese imports, which, of course, is part of the tariff calculus that we’ll get into later.
Regardless, the S&P 500 opened higher, Treasuries rallied, and traders are now betting there’s a 75% chance the Federal Reserve cuts rates by September.
The ultimate takeaway? Inflation has cooled and isn’t a “problem” anymore. The bigger question now is what the Fed does with that information.
Does the Fed Have an Excuse to Not Cut Rates?
The Federal Reserve has a dual mandate:
- Keep prices stable.
- Maximize employment.
The keyword in No. 1 is “stable.” It doesn’t necessarily mean low, although that’s the target. It simply means stable, which really means predictable. You could make the argument that prices are unpredictable now, given the situation surrounding tariff policy, but I also think that’s become an overblown story at this point.
Why? The reality with tariffs is that most of them have been scaled back significantly. This timeline from the New York Times paints that picture quite effectively. The president, on multiple occasions, has scaled back or delayed threatened tariffs while working through individual deals with countries. He’s also been forced into a corner by economic events, namely the bond market turbulence that is very closely linked to the initial rollback of the broad-stroke tariffs announced on April 2.
Currently, the biggest threat that could run up inflation is with China, where tariffs have risen to over 100% between both countries. Given that the U.S.-China trading relationship is worth over half a trillion dollars, it’s imperative that both countries figure it out, but as of today, news broke that there could be an agreement ready to be signed.
Mexico and Canada’s tariff situation can become troublesome if it’s renewed, but many of the tariffs have been rolled back, with only select industries being targeted, namely Canadian metals.
With this being said, I’m not suggesting that tariffs are a complete nonissue, but it’s also not a huge issue. Yet, it’s become the foremost catchphrase that economists continue to regurgitate over and over again despite an evolving narrative.
The fact of the matter is that since January, we’ve been told that inflation will rise and that tariffs will be the culprit. Instead, we’ve seen the opposite. Inflation continues to come in below forecasts, while tariff policy continues to be reversed, amended, or, in some cases, challenged by courts. But for some odd reason, I keep hearing that tariffs are going to create a catastrophic inflationary environment any day now.
So, in that case, I’d lean toward making the argument that Chairman Jerome Powell and the Federal Reserve have, in fact, run out of excuses to not cut interest rates.
Here’s my thought process on that:
- The Fed was already beginning a cut cycle.
- They stopped that cut cycle in anticipation of inflation driven by tariffs.
- The tariff situation played out the way it did, and inflation actually fell.
- Consumer spending, meanwhile, fell as the narrative around the economy soured.
- Lower consumer spending equals less revenue for businesses, which equals layoffs or hiring freezes.
- Unemployment rises.
If the end of this chain of events is an uptick in unemployment, the Fed will have no choice but to cut rates.
So, the question is: Does the Fed wait for unemployment to rise? Or does it proactively cut rates now or sometime soon to keep things running smoothly?
We’ll get a better idea next week when they meet at the Federal Open Market Committee meeting.
