Governor Waller, in his speech about the economy, mentioned that interest rate cuts could occur later this year. This will depend on how inflation changes and whether tariffs stabilize. The strong economy up to April gives the Federal Reserve some time to evaluate trade outcomes. Tariffs might cause a temporary price increase that the Fed can overlook. However, there is still uncertainty around trade policy, which poses risks to the economy and job market. Tariffs are likely to raise inflation this year and could lead to higher unemployment, with effects lasting longer. We may see the effects of tariff-related inflation most clearly in the latter half of 2025.

Focus on Inflation Expectations

Waller highlighted his focus on market and expert opinions about inflation. He considers the long-term effects of tariffs on inflation to be moderate, viewing their price pressures as temporary. Although some surveys show that consumers expect higher inflation, Waller believes the current job market doesn’t allow workers to demand raises effectively. He remains open to rate cuts later this year, choosing to ignore any inflation pressures caused by tariffs, even if the job market stays stable. Waller’s insights clarify how the central bank is looking at price changes. Basically, he thinks the inflation caused by new tariffs may spike but is unlikely to persist. What’s more important is whether that inflation lasts, not just appears and then fades. This perspective helps policymakers be patient instead of reacting too quickly with higher interest rates. The Fed can take a step back now because recent economic data through April shows strong growth. This allows for a wait-and-see approach until there is more clarity. During such times, when market expectations are shifting and bond market signals remain stable, the focus shifts to finer details—like whether wage growth lags behind rising prices or if it starts to catch up. Waller suggests that the balance here shows inflation risks are under control, justifying a wait-and-see approach. Though some surveys indicate that households expect rising prices, other areas of the market Waller monitors show different trends. There’s a reason for this gap. Survey-based expectations often change in response to news, especially about tariffs. However, future-looking measures seen in asset prices are currently stable. This makes those measures more reliable in today’s environment.

Impact on Short-Term Rates Markets

Now, let’s consider how these factors influence short-term rates markets. Earlier this month, expectations for easing returned, but they became unpredictable due to ongoing tariff news. Understanding how the central bank is weighing these risks and selectively ignoring temporary ones helps clarify the picture. It indicates that data sensitivity will be more crucial than reacting to headlines moving forward. If tariffs start leading to widespread price increases, impacting areas like services or wages, policy officials will likely change their tone. But we haven’t reached that point yet. Current inflation readings have been cooling since March. Additionally, weaker-than-expected unit labor costs support Waller’s perspective. Going forward, we need to track how quickly inflation changes, not just the overall level. Meanwhile, employment indicators mainly reflect consumer strength rather than wage pressures. Policymakers are looking for signs that slowing job growth could reduce excess spending without harming overall consumption. In fixed income and derivatives markets, this means volatility will likely respond more to surprising increases in prices than to decreases. A gradual decline in inflation won’t prompt immediate action, as that trajectory has already been communicated. However, if inflation numbers fall sharply, it could reignite expectations for earlier rate cuts. The risk, as Waller has subtly pointed out, is overreacting to short-term changes or expecting persistent inflation where it may not exist. The upcoming period will likely favor quick reactions over firm beliefs. There’s little benefit in sticking rigidly to one view, especially if it overlooks softer data. At the same time, markets shouldn’t react too strongly to noisy inflation reports. We’ll interpret the data like policymakers do: focusing on persistence rather than drama. Create your live VT Markets account and start trading now.

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