Mary Daly, President of the Federal Reserve Bank of San Francisco, expressed concerns about increasing inflation pressure due to widespread tariffs.
She acknowledged that current data reflects solid growth and a strong labour market but warned that tariffs could lead to inflation rising again.
Need for Cautious Policy Approach
Daly emphasised the need to remain steady and assess the overall impact of the administration’s changes, despite the lack of complete clarity on tariffs.
She advocated a cautious approach to policy, stating that Fed policy currently maintains a modestly restrictive stance.
Daly’s comments highlight a tension between ongoing economic resilience and potential policy headwinds. On the surface, indicators such as GDP growth and employment figures remain healthy. However, price dynamics are entering a phase marked by external cost pressure—mostly from trade measures—which can distort core inflation readings. This is not theoretical risk; it is a developing reality.
We must pay attention to how these price inputs shift the broader outlook. Services inflation has already been sticky in recent months, and goods prices, which had been cooling, may begin to firm up again. Any durable shift in inflation expectations could impact how participants price forward rate paths, especially in the second half of the year. Daly’s moderate tone, nonetheless, maintains that monetary conditions are tight enough for now, which suggests the bar remains high for cutting.
Impact on Derivatives Pricing
For derivatives pricing, such signals shift the probability skew. If cost-push inflation accelerates while growth remains sturdy, volatility around rate expectations could widen. Daly’s remarks don’t suggest imminent action, but they reduce the scope for dovish bets in the near term. That tightens the range for floating instruments, and raises the value of near-term inflation hedges.
Participants need to reconsider where real yields are heading under these tariff risks. While nominal terminal rate expectations haven’t shifted abruptly, implied breakevens may adjust as supply chain costs resurface. That means the correlation between breakevens and rate vol may temporarily decouple, and we may see move-driven re-risking around policy meetings.
Additionally, the guidance given remains careful. There’s an implicit recognition that pricing power is returning to parts of the supply chain. For traders in futures and swaps, especially in the front-end, that could mean a reduction in ease-of-exit for more aggressive rate cut views. That repricing could steepen certain areas of the curve where carry remains positive but risk-reward is now more balanced.
Daly’s appeal to patience is a subtle signal that real-time data noise may be misleading. Those dealing in policy-sensitive assets near expiry points — or within high gamma ranges — should weight positions with that messaging in mind. The pull toward re-assessing terminal bets might still be some weeks away, but any firming in CPI will bring that forward.
