Written by: Tim Pierotti
For the past year, we have all heard Fed Governors and macro commentators argue that the Fed should “look through” tariffs and more recently, that the Fed should look through the oil price shock. Our view is that the Fed should look through nothing. They should take the data as it comes and accept that they don’t know the future. As John Kenneth Galbraith once said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” There are several reasons why the Fed should stop “looking through” inflation measures that are above their target, but none more compelling that the fact that they are now entering their fifth year of failing to get the inflation rate down to 2%. Again and again, the Fed and the broader commentariat have assured us of an inflation normalization that hasn’t happened. In real time, we don’t know if an event is just a blip to ignore or a paradigm shift with enduring impacts.
In the case of tariffs, you will often hear economists talk about the rate of inflation “ex-tariffs”, because they assume that these these taxes are a one-time cost and will have no enduring impact. The problem is that the inflation data that reflects the period before the oil spike showed ongoing inflationary pressures caused by tariffs. It takes time for importers to pass through price increases. There is the friction of higher costs via new supply chains or substituted materials and there are retaliations from trading partners. These are not “one-time resets” but a part of a paradigm shift as companies create redundant and less efficient capacity than they previously enjoyed. The global transition from trade cooperation to trade competition may accelerate from here or maybe this will prove to be just an aberrant episode along the long road of a world getting more flat or more integrated. It doesn’t feel like it, but who knows.
Is this oil spike a temporary event or part of a paradigm shift? I don’t know of course, but with every passing day that a decimated Iran still has the power to disrupt global oil traffic, it seems more likely this is more than an event. Cheap and accessible military technology like drones have changed the way wars will be fought. One thing has become clear since the Houthi’s started creating trouble in the Red Sea is that drones are going to have an enduring and unpredictable impact on energy storage and transit and global commerce in general.
There is also the argument that taxes (tariffs) and oil price shocks are inherently deflationary as those costs lead to lower corporate profits and crowd out consumer spending on other items. That may be ultimate result, but only because they are highly inflationary first. Either way, the Fed doesn’t know how these events play out, or what the knock-on effects are and that is why they should have the humility and discipline to respect the data as it comes and have the apolitical courage to achieve their inflation mandate.
High ongoing and cumulative inflation is unhealthy for our country. Rising asset prices amid higher cost of living exacerbates our economic and societal bifurcation further. The Fed should stop guessing what is an event and what is a paradigm shift.