According to the former No. 2 at the U.S. central bank, the Federal Reserve’s efforts to protect against inflation are far from over.
Although the cost of living has been approaching the Fed’s 2% annual target, President Donald Trump’s tariffs may still cause pricing pressure in the months ahead.
“What we do know is that since January inflation data has come in better than anticipated,” stated Richard Clarida, who served as vice chair of the Federal Reserve from 2018 to 2022 and is currently a global economic consultant at the bond behemoth Pimco, which manages assets worth approximately $2.03 trillion.
In April and May, tariff receipts increased, but inflation data has not yet taken higher costs into account.
See: May retail sales overview highlights threat to U.S. economic development
The Fed’s favored inflation indicator, the PCE index, reflects this, rising to a 12-month rate of 2.1% in April from 2.3% the previous month, marking the lowest level since the pandemic.
According to Richard Clarida, the first market quote he checks every morning is the yield on the 10-year Treasury. The previous vice chair of the Fed stated that it is “the anchor for the entire global fixed-income market.”
However, those positive numbers might be hiding the long-term consequences of American businesses’ first-quarter inventory frontloading. In order to avoid duties, a large portion of that inventory was pulled forward; nevertheless, future shipments from China to stock U.S. shelves would now be subject to higher levies.
The Yale Budget Lab estimates that the average effective tariff rate for consumers in June was 15.6%, the highest since 1937.
Clarida added that inflation may move into the low-3% level. “We still expect tariffs to push up measures of inflation for a while as we keep getting data,” she said.
“Versus ‘liberation day,’ those maximum tariffs are looking lower than what many people thought,” he stated. “But we do expect it will show up.”
When Trump declared new duty rates on imports from the majority of the world’s nations in the White House Rose Garden in the early afternoon of April, he dubbed it “liberation day.”
Bond market alert
In the $29 trillion Treasury market this year, there have been concerns about inflation predictions as well as the enormous U.S. debt and deficit estimates under the Republican tax policy.
In recent months, investors, particularly those with longer time horizons, have been calling for higher yields to act as creditors to the United States. The yields on the 10-year Treasury, BX:TMUBMUSD10Y, and the 30-year Treasury, BX:TMUBMUSD30Y, were rising as a direct result of that. As of Monday, they were at about 4.45% and 4.96%, respectively.
Rising longer-duration yields increase the cost of funding for businesses, families, and the US government.
According to Clarida, the first market quote he checks every morning is the yield on the 10-year Treasury. He stated, “It is the anchor for the entire global fixed-income market,” adding that shifts in yields can be a reflection of shifting expectations regarding Fed policy, economic growth, and flight to safety.
According to Clarida, the “fingerprints” of the “bond vigilantes” seem to be already evident in yields that are higher and last longer. “Foreign investors,” he stated, “want to get paid to hold Treasurys, which is one reason they are picking up a higher yield.”
Trump blamed the 90-day halt on his so-called reciprocal tariffs on “yippy” bond yields.
However, Pimco anticipates that 10-year yields will mostly stay in the 3.5%–5% range that they have been in since the Fed began hiking interest rates two years ago due to a spike in inflation during the economy’s recovery from the epidemic years.
Fed to continue being independent
Ahead of the Fed’s two-day meeting, which begins Tuesday, the White House has been stepping up its criticism of Fed Chair Jerome Powell’s wait-and-see strategy for rate decreases.
According to Clarida, the key question at this week’s Fed meeting will be whether the FOMC still plans to approve two interest rate decreases this year or if that number will be lowered to just one.
Following the conclusion of the meeting on Wednesday, the Fed will release an updated summary of economic estimates, including the number of rate decreases members anticipate this year, but no change in interest rates was anticipated.
Prior to the “liberation day” tariffs shocking markets and international trading partners, the Fed’s final set of predictions was presented during the March meeting.
In light of this, the true debate, according to Clarida, will be whether the Fed will still approve two interest rate decreases this year or if that number will be down to just one.
See: How the Fed could pave the way for a particularly significant rate decrease in September: Standard Chartered
According to the CME FedWatch Tool, the chances on Monday supported two rate decreases, lowering the Fed’s policy rate to between 3.75% and 4% at the central bank’s December meeting.
Clarida stated that he does not believe that the Fed’s independence in setting interest rates is in danger, despite Pimco’s argument in a new five-year outlook that Trump’s second term marks a new age in which politics drives economics.
Citing actions taken by the Trump administration to mandate that the White House’s Office of Management and Budget review Fed decisions on financial supervision and regulation, Clarida stated, “We may be going to a world where the Fed loses some power in the regulatory sense.”
The ‘base case’ of Clarida anticipates that the Fed will maintain the majority of its political independence even after a Supreme Court decision upheld the validity of the Trump administration’s dismissal of an NLRB member.
Clarida said, “But it looks like the Fed retains independence to raise or lower interest rates,” alluding to the Supreme Court’s ruling that upheld the Trump administration’s right to fire a National Labor Relations Board member while implying that the Fed would be protected from similar dismissals.
According to Clarida, the decision made him anticipate that the Fed would eventually be granted safe harbor, or a carve-out, by the Supreme Court.
He added that the Senate and financial markets would probably conduct a thorough screening of any new candidate for the Fed chair position.
“I think markets can have a say,” Clarida stated, adding that if a Fed candidate isn’t seen as independent or dedicated to lowering inflation, he could predict a sharp decline in equities and bonds.
“Those are two reasons for the Fed’s independence being preserved.”
