Federal Reserve Governor Christopher Waller remarked on tariffs introduced by the Trump administration, suggesting they presented a shock to the US economy. He indicated these could necessitate a rate cut to prevent a recession, yet they might also serve as a mere negotiation tactic with minimal long-term effects.
The new tariff policy is considered one of the greatest economic shocks in decades. Waller anticipates that inflation resulting from tariffs will be temporary. If the 25% average tariff rate persists, inflation might peak near 5%, potentially causing a prolonged impact on output and employment and increasing unemployment to 5%.
Federal Reserve Rate Cut Considerations
In this scenario of heavy tariffs with a slowing economy, Waller supports an earlier and larger rate cut than previously intended. If tariffs reduced to 10%, inflation might peak at 3%, with a limited impact on economic activity. A smaller-tariff situation could allow the Fed more patience, possibly delaying rate cuts to later in the year.
There remains high uncertainty in policy, necessitating Fed flexibility. Partial tariff suspensions have broadened potential outcomes, complicating timing. Inflation expectations have not destabilised, with inflation likely to moderate by 2026. As of Q1, economic growth was modest, the labour market strong, and inflation high but gradually easing, with March’s PCE 12-month inflation at 2.3% and core PCE at 2.7%.
The Federal Reserve’s Waller has laid out a relatively clear framework for how shifting trade policy might collide with monetary policy over the coming quarters. At its core, he’s weighing the inflationary rise from tariffs against the deflationary drag they’re likely to impose on growth and employment. To put it plainly, if the price impact of tariffs proves sharp and short-lived, the rate path may well accommodate looser policy sooner than previously considered.
When tariffs were first reintroduced during the Trump administration, they sparked wide-ranging concern within economic circles. Now, with new iterations or renewals of these policies potentially resurfacing, Waller reminds us that they still act as an external jolt — comparable to a supply shock — capable of unnerving both unemployment and price stability. Consider the scenario he outlines: a 25% average tariff doesn’t just increase consumer prices momentarily — it raises the possibility of disinflation following on the back of weakened demand, while the jobs market softens enough to warrant a measurable shift in interest rates.
Impact Of Tariff Levels On Inflation And Policy
This is not just speculation from Waller, it’s a window into the Fed’s thinking process. Especially for those directly involved in rate-sensitive exposures, his argument suggests that the central bank could move earlier and more aggressively should trade actions hold or escalate to their higher thresholds. Even talk of a 5% inflation peak, winding its way through the supply chain and consumption data, points to a moment where economic activity would be dampened beyond the Fed’s tolerance for inaction.
If, however, tariffs settle closer to 10% — as seems possible given the kind of back-and-forth seen previously — then inflation, while not trivial, could remain within limits the Fed finds manageable, peaking near 3% by Waller’s estimate. In that case, rate reductions may not come on the front foot but rather be delayed until later in the year, allowing time for broader indicators to confirm any deceleration in growth or slack emerging in employment figures.
One added complexity is the variable nature of trade policy itself. With some levies already suspended in part and more possibly revised as negotiations continue, the range of potential outcomes has widened — forcing policymakers to stay nimble. We must keep this in mind as volatility in rate expectations shifts with each policy update or macro release. There is no fixed course when geopolitical drivers lean so heavily on short-term price dynamics.
Market participants might also take some comfort in Waller’s calm regarding inflation expectations. Despite the headline figures sitting above target, with PCE inflation at 2.3% and core PCE at 2.7% in March, medium-term trends still suggest a gradual cooling. This supports the ongoing Fed narrative: inflation is on a controlled descent back toward target, absent further shocks.
Moreover, as of the first quarter, we see the economy growing at a moderate pace — not weak per se, but certainly no longer overheating. Labour remains tight. But if that begins to loosen, the broader disinflationary forces accompanying it may bring forward the timing of policy changes. Whether the Fed acts pre-emptively or waits for a series of weaker reports will depend on how trade-related inflation manifests in the data.
In this environment, reading official commentary closely becomes an advantage. Watching real output, employment indicators, and import price data — particularly those linked to tariff-affected goods — could provide earlier cues. Short-dated vols, as well as mid-curve rate structures, may need to reflect more uncertainty than they presently do. Reaction function assumptions need to be stress-tested under two branches: a high-tariff high-inflation path demanding earlier easing, versus a low-tariff scenario allowing a more delayed or even shallower policy response.
Ultimately, policymakers continue to play with a limited hand, guided more by the sequence of economic outcomes than by ideology. Tariffs remain a noisy variable introduced mostly outside the traditional economic arena, yet their effects have found their way back into the central bank’s decision making. For now, adaptability—grounded in a firm macro read—is what the environment demands.
