Rob Kaplan on How the Fed Will Think about the Tariffs

Episode Summary

Executive Summary: The episode centers on how tariffs, fiscal tightening, immigration restrictions, and energy-market shifts are creating a stagflation-like dilemma for the Fed. Former Dallas Fed president Rob Kaplan argues policymakers should be patient, data-dependent, and focused on risk management rather than forecasting, while markets grapple with falling stocks, rising yields, and unusual stress in Treasury plumbing.

Main Topics: Fed policy under stagflation risk (Priority: 5/5): Kaplan explains why the current environment is unusually hard for the Fed: inflation is still sticky, growth may slow, and tariffs could worsen both at once. Tariffs as a supply shock and growth shock (Priority: 5/5): The discussion emphasizes that tariffs are likely to raise goods prices while also slowing activity, creating uncertainty the Fed cannot easily model. Market volatility and Treasury selloff (Priority: 5/5): The hosts and Kaplan discuss the unusual simultaneous decline in stocks and bonds, including possible basis-trade unwinds and global reallocation away from dollar assets. Business and investor response to policy uncertainty (Priority: 4/5): Companies are pausing decisions, pressuring suppliers, and avoiding new U.S. capacity until tariff policy becomes clearer; investors are reducing dollar exposure. Energy sector slowdown and oil prices (Priority: 4/5): Kaplan says drilling activity is likely to remain cautious because of lower prices, higher costs, and shareholder pressure, even with pro-drilling rhetoric. Structural changes in the U.S. economy (Priority: 4/5): Kaplan outlines five broader shifts: lower fiscal spending, regulatory review, energy restructuring, tighter immigration/labor supply, and tariffs.

Key Arguments: The Fed enters the tariff shock with an existing inflation problem, unlike 2019, so it cannot preemptively ease without risking more inflation. Monetary policy can smooth disruptions but cannot solve structural trade, fiscal, immigration, or energy-policy changes. Tariffs are a supply-side shock that may raise prices on goods, but they also risk slowing growth enough to offset some inflation. Markets are reacting to policy uncertainty rather than a known final tariff regime; both businesses and investors are waiting to see whether negotiations meaningfully change outcomes. The selloff in Treasuries alongside equities is concerning because it may signal basis-trade unwinds, foreign or domestic reallocation away from dollar assets, or stress in market function. The Fed will likely act only after hard evidence of slowing emerges, and it will prioritize orderly Treasury market function. Energy producers are likely to remain disciplined; lower oil prices and higher costs make a surge in U.S. drilling unlikely despite political pressure. Kaplan sees tariff policy as potentially reversible by negotiation, but the uncertainty itself is already slowing investment and consumer/business decisions.

Data Points: Date of recording: April 8, 2025 - Hosts note the episode was recorded after market close during a volatile trading day. S&P 500 daily move: -1.57% - The index ended lower after being up more than 4% intraday. S&P 500 intraday move: +4%+ - Used to illustrate severe market whipsawing during the session. 10-year Treasury yield: ~4.28% - Hosts note the yield rose sharply during the market selloff. 10-year Treasury yield earlier level: just under 4.0% - Referenced as the yield before the recent jump. PCE inflation: 2.5%-2.75% - Kaplan cites this range as the current inflation backdrop. U.S. federal deficit: 6.5%-7% of GDP - Kaplan says the administration is trying to reduce the deficit from this range. U.S. net debt-to-GDP: mid-70s% to over 100% - Kaplan describes the rise from 2019 to the present. Annual Treasury debt growth: at least $2 trillion per year - Kaplan highlights the scale of debt issuance the Treasury must market. U.S. Treasury debt outstanding: $36-$37 trillion - Kaplan cites the size of the Treasury market that must be financed. Debt-to-GDP: 100%+ - Kaplan says this makes confidence in U.S. debt markets especially important. Fed rate cuts in 2019: 3 cuts - Kaplan recalls the Fed’s preemptive response to the last tariff episode. Oil price level to spur drilling: around $80/barrel - Kaplan says drilling is more attractive at higher prices. Oil price level with weaker drilling: $50s-$60s/barrel - Kaplan says activity would likely be more tepid at these levels. Dallas Fed Energy Survey timing: quarterly - The hosts discuss the survey as a key source on drilling economics. Low-income purchasing power loss: 25%+ - Kaplan says lower pump and power prices matter because households have lost significant purchasing power.

Pivotal Quotes: "Don't be a prognosticator. Be a risk manager." — Rob Kaplan: Kaplan’s core advice for the Fed and markets amid tariff uncertainty. "We don't have to have this figured out because we can't have it figured out." — Rob Kaplan: He argues policymakers should wait for clearer evidence before acting. "What I'm worried about is full employment and price stability." — Rob Kaplan: Kaplan explains the Fed’s mandate and why stock declines alone are not enough to trigger action.

Implications: Listeners should expect continued volatility as tariffs and policy uncertainty feed stagflation risks. The Fed may stay patient longer than markets want, Treasury-market stress bears watching, and businesses may delay investment until trade rules become clearer.