Cheerleading, Tariffs Come With Cost

Economic Slowdown Is New Risk

We have heard Federal Reserve Chairman Jerome Powell reassure us repeatedly that central bank policy can shift quickly as circumstances change. It could tighten policy promptly if prices rise faster than anticipated, or ease if economic growth slows. There are two potential problems with this approach, both of which the Fed may encounter during coming months.

First is the Milton Friedman dictum from the 1950s that monetary policy affects inflation with a long and variable lag. Professor Friedman meant to suggest, for instance, that monetary tightening intended to mitigate inflation could, in fact, have a delayed impact and worsen an already incipient recession. The second challenge that Powell and his colleagues could face is that inflation and economic growth turn out not to be an either - or proposition but occur simultaneously. This is the situation known as stagflation.

Recent economic data and consumer confidence numbers suggest that the Federal Reserve may have to pay the price for downplaying the significance of these eventualities. Massive monetary easing — alongside a huge fiscal expansion — in 2020 - 2021 resulted in US inflation peaking in mid-2022 at a level not seen in four decades. As interest rates were hiked starting in 2022 even as the fiscal deficit surged, economic growth was maintained but inflation remains above Fed target.

Now, consumer confidence is dropping sharply due to the general public’s fear that the impact of tariffs will be reflected mainly in the prices that they pay for essential goods and services. President Donald Trump has repeatedly stated that the impact of the tariffs will be borne primarily by exporting countries. Surveys suggest that consumers believe otherwise. The drop in consumer confidence has cut into spending according to data released yesterday by the US Bureau of Economic Analysis, increasing the recession risk.

The Fed’s quandary is best shown by personal spending numbers for January released yesterday by the BEA. While disposable personal income rose by 0.9% last month — a healthy increase — personal spending actually fell by 0.2%. Personal savings as a percent of disposable personal income increased to 4.6% as consumers cut back on spending as they fear the impact of the new fiscal and tariff measures. And the latest estimate of economic growth in the current quarter made by Federal Reserve Bank of Atlanta’s GDPNow took a plunge. The growth estimate turned abruptly down from +2.3% on February 19 to -1.5% on February 28.

Economic storm clouds are looming for the Federal Reserve and the Trump administration.

The question the Fed Chairman ought to be asked at his next post-Federal Open Market Committee press conference would be, “Mr. Chairman, are you going to cut interest rates in response to the growth slowdown, or are you going to raise rates to ensure that inflation comes down to the 2% target?” Powell may have no theoretically consistent response to that question.

With Trump indicating that new tariffs on Canada and Mexico may become effective on Tuesday, and China already experiencing the first set of higher tariffs, the FOMC is likely to leave the policy rate unchanged at its next meeting on March 18 and 19. But making no change cannot be a permanent policy. The Committee will soon have to deal with the inflation-plus-employment problem with an up or down decision on rates.

What will all this mean for the yield on 10-year Treasurys which fell sharply last week as recession fears dominated the investment scene? With no expectation of a rapid reduction in the fiscal deficit resulting from DOGE measures, yields will encounter upward pressure from the Treasury’s continuing substantial borrowing need. And if inflation remains stubborn at levels much higher than the Fed’s 2% target, expect bond yields to be eventually higher despite investors’ fear of a recession.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

March 1, 2025

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Sri-Kumar Global Strategies, Inc. assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. Sri-Kumar Global Strategies, Inc., or its employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time without notice. ©Copyright 2025 -- Sri-Kumar Global Strategies, Inc., 312 Arizona Avenue, Santa Monica, California 90401; Telephone: +1-310-455-6071