Are They Walking a Tightrope?

Executive Summary

The Fed is boxed in on how to deal with inflation, with the weakening jobs market combined with the possible inflationary impacts of tariffs, proposed stimulus, and lower interest rates. In the first graph below, one can see from 1967-1983 inflation came in three waves (using CPI). Comparing that period to the period from 2015 – current (second graph using Core CPI), one might consider the U.S. potentially entering a third wave. The concern of many is a combination of lower interest rates, tariffs and proposed government stimulus causing a third wave. With the Federal debt at $38 trillion and annual Federal budget deficit of almost $2 trillion, no one in Congress wants the pain of budget cuts. Walking the inflationary tightrope by the Fed and the Federal government is going to be next to impossible to pull off.

For further analysis, continue to read The Details below for more information.

“There are no solutions. There are only trade-offs.”
–Thomas Sowell

The Details

The U.S. continues to run enormous deficits. For fiscal year ending September 30, 2025, the deficit is estimated to be around $1.8 trillion. Averaging various projections for fiscal 2026 suggests a deficit of around $2 trillion…give or take a couple hundred billion. There are numerous factors that could impact next year’s deficit, including: the extent of fiscal stimulus enacted; further loosening of monetary policy; and the effects of tariffs. The Fed is boxed-in as they attempt to determine if the weakening jobs market and debt-strapped consumer warrant further interest rate cuts, while weighing the inflationary impact of lower interest rates, fiscal stimulus programs, and tariffs. The President has enacted tariffs using the International Emergency Economic Powers Act (IEEPA). The authority to enact tariffs under this act is currently under review by the Supreme Court.

According to TaxFoundation.org,

“The Trump tariffs amount to an average tax increase per US household of $1,200 in 2025 and $1,600 in 2026. […]

Under the tariffs imposed and scheduled as of November 1 the weighted average applied tariff rate on all imports rises to 18.1 percent, and the average effective tariff rate, reflecting behavioral responses, rises to 13 percent—the highest average rate since 1941. […]

Historical evidence and recent studies show that tariffs are taxes that raise prices and reduce available quantities of goods and services for US businesses and consumers, resulting in lower income, reduced employment, and lower economic output.”

While the inflationary impact of tariffs is hotly debated, overall inflation is a serious concern for policymakers. Reviewing the last bout of inflation from 1967 to 1983, it came in three waves as shown in the following graph from economist John Mauldin.

Also from John Mauldin, the following graph prepared by Crescat Capital compares today’s inflationary cycle to the previous one. The difference in the graphs is the one above uses the CPI while the one below incorporates Core CPI which excludes the more volatile sectors such as food and energy.

In the prior inflationary cycle, the largest increase came in the third wave. The concern of many is that a combination of lower interest rates, tariffs and the proposed stimulus – paying a “dividend” of $2,000 per citizen – could cause a rhyming third wave.

While GDP is being boosted by enormous spending by a handful of companies on AI (artificial intelligence), the jobs market is weakening rapidly, and consumers are pulling back their spending as delinquencies on car loans and home foreclosures jump. The economy is bifurcated into the ultra-wealthy who have benefited from asset price bubbles and the remainder who are struggling with debt and high prices. At the same time the Federal government is over $38 trillion in debt, resulting in annual interest costs over $1 trillion.

Walking the inflationary tightrope by the Fed and the Federal government is going to be next to impossible to pull off. Especially in an environment where cutting the Federal budget seems unthinkable by Congress. So, a continuation of massive deficits and soaring National debt appears unstoppable. If the Fed were to raise rates on inflation fears, and the Federal government decided not to issue any economic stimulus, but instead initiated significant budget cuts, inflation would likely give way to a significant recession or depression. This would allow for the debt to be reset through defaults and restructuring, albeit with much pain. Politicians always wanting to avoid pain on their watch, will choose the stimulus route instead, which merely inflicts a different kind of pain…high inflation.

The S&P 500 Index closed at 6,734, up 0.1% for the week. The yield on the 10-year Treasury 

Note rose to 4.15%. Oil prices remained at $60 per barrel, and the national average price of gasoline according to AAA remained at $3.07 per gallon.