MNI INTERVIEW: Tariff Growth Hit Will Force Fed To Ease-Tilley
MNI (WASHINGTON) - An already softening economy is facing a new drag from uncertainty surrounding tariff policies, a weakening backdrop that will force the Federal Reserve to cut rates by a full percentage point in the second half of 2025, former Philadelphia Fed economic advisor Luke Tilley told MNI.
Tilley said the big takeaway from this week’s FOMC meeting is that policymakers are looking at the inflationary effect of tariffs as likely to be transitory. That indicates they will resume rate cuts by June, particularly if the labor market shows signs of slowing.
“They had a message that they were much less worried about inflation in March than in January – specifically, about the impact of tariffs,” Tilley said in an interview Friday.
The Fed will cut rates as many as four times in the second half of the year to support what will by then look like a fraying economy, Tilley said. Consumer spending is already showing signs of slowing, he said, while topline strength in the labor market masks softness in hiring and job availability.
“The economy isn’t as strong as people thought it was. That actually does play into how you think about tariffs because if tariffs drove up prices and consumers were in really good shape and they could handle it, it would be likely more inflationary,” he said.
“If consumers are not as strong as you thought, the price on all the imports are going to go up, that means they're going to spend less on haircuts and restaurants and vacations, trips to Disney World and everything.” (See MNI INTERVIEW: Fed To Focus On Growth Drag From Tariffs-Sahm)
RECESSION RISK
If President Donald Trump's tariff threats do devolve into a full blown trade war, then it would push the U.S. economy into recession, said Tilley, now chief economist at Wilmington Trust. As it is the chances of a recession are running at about 35%, he added.
“We’ll have recession on our hands if it’s a full blown trade war and the tariffs go in and stay in."
With "the uncertainty right now, businesses don't know if they should pull the trigger on capex or wait. They don't know if they should hire or wait. We've got the average work week falling. You've got over average overtime hours falling. And businesses are in a bit of limbo. So my personal opinion, is that a trade war ends up being a net negative, and it ends up pulling down on inflation.”
NOT CLOSE TO NEUTRAL
Some Fed officials have argued that the Fed should be reluctant to cut interest rates further because the neutral rate of interest has likely risen. Tilley does not agree with that theory.
“I don't think that we're close to neutral. There are two ways people get at that. It's like, well, we've had high rates and the economy is still really strong – the neutral rate must be higher. Or, inflation is still high, therefore we might we must not be pressing on the brake as hard as we think. And I take issue with both of those.”
Tilley believes instead that strong productivity growth is what has allowed disinflation to coexist with a robust expansion.
“If you have strong productivity growth, you can have stronger GDP and have inflation fall. And I see productivity growth everywhere, my business, every coffee shop I walk into, every insurance company that I talk to.”
As for inflation, he argues it has already been below the Fed’s 2% target if you strip out the stubborn shelter component of price pressures.
“If you take the CPI and remove the shelter component, which is drifting down, it's just taking a long time. Everything else, the basket ex-shelter, has been below the Fed's target for 18 months."