Russia and Waller
June 2, 2025
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–I tend to think that Ukraine’s attack on Russia’s airfields and bombers is massive news. I believe there’s true uncertainty about responses going forward. I also think Nawrocki winning the Polish presidency is important, signaling a shift away from Brussels. I understand the bid in gold and oil, but am less certain as to why equities remain relatively strong. GCQ +55.6 at 3371, CLN5 +2.13 at 62.02, ESM -38 at 5878. The press seems to be ignoring possible secondary effects.
–Volatile stocks. SFRZ5/Z6 -56.5. low -59 this week. New buyer 23k SFRZ5 9700/9800cs for 5.0/5.25 (5.25s).
–Excerpts from Waller’s speech yesterday:
I will focus my comments on two issues: first, the effects of tariffs on inflation persistence, and second, the divergence of household inflation expectations and financial market measures of inflation expectations.
He outlines differences between small and large tariff outcomes (large could lead to both inflation and unemployment reaching 5%, but the inflation would be temporary).
The smaller-tariff scenario assumed a 10 percent average tariff on goods imports would remain in place but that higher country and sector specific tariffs would be negotiated down over time. In this case, inflation may rise to 3 percent on an annualized basis and then dissipate. Growth in output and employment would slow, with the unemployment rate rising but probably not as high as 5 percent.
As of today, I see downside risks to economic activity and employment and upside risks to inflation in the second half of 2025, but how these risks evolve is strongly tied to how trade policy evolves.
Thinking about the rest of 2025 and 2026, I expect the largest factor driving inflation will be tariffs. As I said earlier, whatever the size of the tariffs, I expect the effects on inflation to be temporary, and most apparent in the second half of 2025. This will be determined not only by the ultimate size of the increase, but also by how exporters and importers respond, something that is highly uncertain.
Inflation turned out to be much more persistent than we thought it would be. Am I playing with fire by taking this position again? It sure looks like it. So why do I believe a tariff-induced inflation spike will not be persistent this time?
The University of Michigan’s Surveys of Consumers show that both near- and longer-term inflation expectations have increased strikingly, on net, in the past few months and currently stand at 6.6 percent and 4.2 percent respectively. Meanwhile, inflation expectation measures based on prices of nominal versus inflation-adjusted securities have not increased very much, with 2-year Treasury Inflation-Protected Securities inflation compensation around 2.7 percent and 5-year and 10-year around 2.4 percent. Also, the median from the Survey of Professional Forecasters for consumer price inflation 6 to 10 years ahead is at 2.2 percent.
Concluding:
Assuming that the effective tariff rate settles close to my lower tariff scenario, that underlying inflation continues to make progress to our 2 percent goal, and that the labor market remains solid, I would be supporting “good news” rate cuts later this year.
