Tariffs are a major determinant of the growth outlook, so staying on top of various perspectives on this issue seems worthwhile. I do not know how the tariff story will play out, and there is two-way risk here. But my take on the economics is that this is an important issue, probably more important than is even now recognized. And Dudley’s take (HERE) is in line with that. Just look at the title: ‘These Tariffs Will Be Worse Than Markets Think’.
I could not really tell whether Dudley expects this story to put upward or downward pressure on interest rates, net net. And I suspect there might even be a typo in the summary line suggesting bond yields will fall, as that would be a case of a presumably “good” market development. That aside, I can see the ambiguity here, because tariffs slow growth and put upward pressure on inflation, which have offsetting effects. And we do not really know if tariffs hikes will be paired to income tax cuts. The greater income taxes are cut, the higher the odds are that bond yields end up going higher, for reasons I mentioned in my note yesterday.
More to the point, I do think that Dudley is right to point out that the tariffs mean slower growth. I would only have been more keen to point out that the reason this is the case is that higher inflation reduces the speed limit that the Fed will impose on the growth outlook. And this is almost dispositive because when the economy is away from liquidity trap, the Fed retrieves its traditional last mover advantage, and effectively determines (while looking at inflation) what the central case outlook for growth will be. The Fed can make mistakes, of course, but those mistakes are idiosyncratic. So the speed limit does determine the central case, at least for all points beyond the horizon at which monetary policy may be expected to take effect. This is a slightly complicated thought, but it is important to internalize it. So, I am going to keep hammering on it.
If inflation is an issue, then the Fed will insist on limiting growth to below-potential and to taking the higher recession risk associated with that. So, higher tariffs mean a weaker growth outlook, and vice versa. It really is that simple. If the economy is inclined to weaken on its own, a prospect Dudley emphasizes, then we get the weaker growth outlook without the Fed raising rates (relative to the non-tariff baseline). If the economy does not weaken on its own, perhaps because of income tax cuts, then we still get the slowdown. It is just that monetary policy must be tighter to deliver the required result. On why this is the case, I mostly agree with Dudley. I would just be much more direct about it.
Tariffs mean slower growth. All that is left to argue about is how. Tariffs are part of an anti-growth agenda, which is why the Trump Administration is being more direct about recession risks, while trying to put some distance between their policies and the risk of that. That part is just politics. But the point itself is fairly simple, and it does not turn on whether the Fed ends up cutting or raising rates, although that part is important to fixed income.
