Non-tariff Inflation Transitory?

Oh, the yarns spun by the Fed - they never get tiresome, or do they? Investors have to stay on their toes when it comes to Fed speak, geopolitical events, and the like. What is

an investor to do? This week's inspiration for the musings is the 1982 hit song "Twilight Zone" by Golden Earring. Here's some trivia about the song:

• This song reached #10 on the Billboard charts in the U.S., but in their home country of the Netherlands, it hit #1 on the charts. The band is more well-known for this song in the U.S., but their more notable global hit was the 1973 song "Radar Love," which falls more in the hard rock genre.

• Contrary to the title, this song actually has nothing to do with the television show "Twilight Zone," nor the song by Manhattan Transfer with the same title. Golden Earring guitarist George Kooymans was inspired by the Robert Ludlum book "The Bourne Identity," which later became a successful movie series.

• The success for this song is largely due to the non-stop play of the music video on MTV. The video featured lead singer Barry Hay as an espionage agent apprehended by three henchmen, played by the other members of the band.

• For those readers who were born in the 1990s or later, the MTV Effect was very real. Rick Springfield has been quoted as saying, "The difference that I saw was, before MTV, you'd have to be on like your third successful album before people started recognizing you at the airport. But once MTV hit, you had that one hit single, and you were as recognizable as if you were around for three or four years. It was so instant."

"Help, I'm steppin' into the twilight zone

Place is a madhouse, feels like being alone

My beacon's been moved under moon and star

Where am I to go now that I've gone too far?

So you will come to know

When the bullet hits the bone

So you will come to know

When the bullet hits the bone

I'm fallin' down a spiral, destination unknown

Double crossed messenger, all alone

Can't get no connection, can't get through

Where are you?"

Here's what we've seen so far this week..

Destination Unknown? The Fed repeatedly states that they are "data-driven" when it comes to making or adjusting policy. However, it would seem lately that the Fed has

shifted its focus to more of a forecasting model, as opposed to what the data reveals. In comments made during his post-FOMC meeting this week, Powell stated, "We expect a meaningful amount of inflation in the coming months." The Fed has stressed this would come from current tariff policy. And yet, we have not seen considerable inflation since "Liberation Day" back in April. In fact, the Cleveland Federal Reserve estimates June's CPI number to be higher by 0.2%. That comes in contrast to May's paltry 0.1% increase. For some perspective, when inflation was rising post-COVID in 2021, the average monthly increase in inflation was +0.6%. In 2022, the monthly average was only slightly lower at +0.5%. So is the lack of tariff-related inflation "transitory"? First Trust Chief Economist Brian Westbury duly noted recently, "When was the last time the Fed made a rate decision based on a forecast of what a specific fiscal policy would do?

Meanwhile, the Fed's economic projections released this week denote fewer rate cuts, higher unemployment, higher inflation, and slower growth. If "stagflation" is what the Fed is seeing in the data (as a reminder, stagflation exists when the economy is suffering from higher unemployment, rising inflation, and declining growth), then why wait on cutting rates? That would be an interesting question to ask inside the FOMC meeting, as there seems to be dissention among the ranks. At least 8 of the FOMC members believe cutting rates twice in 2025 is appropriate. Seven of the members voted for no rate cuts this year. The remaining four were split between one and three rate cuts. In other words, the majority of the members seem to be deviating from Powell's main stance on rates. Could it be that some members have motivation to leave rates as they are for reasons other than the data, or is the data itself being misinterpreted?

Double-crossed Message? The difference between expectations from inflation and tariffs seem to be at peak levels and our contention is that the expectations are not

realistic. The "Misery Index" became popular in the 1960s based on work done by economist Arthur Okun. It is derived by adding the Unemployment Rate and the Inflation Rate. The current Misery Index stands at 6.6, which is below the historical average of 9.2. However, the Expected Misery Index, measured by taking the University of Michigan's Consumer Expectations of Inflation and Unemployment, is at 70.6 (more than 10x the current real level). Why such disparity?

The answer lies in what people expect from current tariff policy and what is actually happening in real-time. Products that many expected to rise in terms of costs due to tariffs have actually not risen. Auto repair, New Vehicles, and Apparel were expected to increase under the current tariff policy, yet all three were down in the May CPI reading (-0.1%, -0.3%, and -0.4%, respectively). The primary reason is because the tariffs on these goods coming into the U.S. have gone down. China has, for the time being, reduced tariffs on U.S. goods from 125% to 10%. The U.K. has reduced tariffs on U.S. goods causing the U.S. to reduce tariffs on U.K. autos coming into the U.S. Producers in the U.S. have been able to eat whatever incremental increases may be realized by buying foreign goods, because their goods going overseas are subject to lower tariffs. If this dynamic remains, the question becomes how "transitory" is the lack of tariff-related inflation?

This Place Is A Madhouse.  Every once in a while, there are geopolitical risks that rear their ugly heads and it typically sends markets reeling. In these situations, mainstream

media never hesitate to pounce. But, should investors care? In the 1990s, the phrase, "I have the t-shirt" became widely popular as a symbol of participation or experience in an event, concert, festival, etc. As such, investing has taken on a similar shift in culture as people believe that owning securities is some form of existential moment. When news emerged that Israel and Iran were entering into a conflict and that the U.S. might get involved, equities pulled back about 1.5%. Markets abhor uncertainty, which explains the pull back. As of this writing, the news cycle has changed as the price of Oil has retreated nearly 2% on news that the Trump administration is trying to negotiate some type of peace between the two countries. Whether that is successful or not, the point is that investing based on a headline is a bad philosophy.

The reality is that markets have experienced all sorts of geopolitical events and yet the long-term trend is higher. There will always be data points of concern in the economy and external geopolitical concerns that could affect markets. The broader picture tells us the economy is in good shape. If for no other reason, the Fed has refused to cut rates, which means the economy must be on solid enough ground, otherwise we would see action. No Fed governor wants to preside over a recession or depression. For the time being, stick to your investment strategy and leave the worrying to others.

Investors need help, we're stepping into the Twilight Zone...

____________________________________________________________________________

Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.

Past Performance does not guarantee future results.