Christopher J Waller: One Transitory Shock After Another

Why It Matters

The outlook determines whether the Fed will maintain a restrictive stance or pivot to rate cuts, directly influencing borrowing costs, investment decisions, and inflation dynamics across the economy.

Key Takeaways

• Iran conflict pushed Brent to $95/barrel, spiking headline inflation.
• Net immigration fell to ~400k in 2025, near zero in 2026.
• Labor‑force growth stalled, reducing monthly job creation need to near zero.
• Underlying core inflation near 2% after stripping tariff effects.
• Fed may hold rates now, consider cuts only if labor market weakens.

Pulse Analysis

Waller’s assessment underscores how geopolitical risk can quickly translate into macro‑economic pressure. The Iran‑Israel confrontation has not only sent Brent crude from $61 to $95 per barrel but also lifted gasoline to $4.10 a gallon, pushing 12‑month headline inflation to roughly 3.3% and core PCE toward 2.6%. These spikes are classic supply‑side shocks, yet the Fed’s traditional "look‑through" approach may be strained when shocks arrive in succession, as seen with pandemic‑era disruptions and now tariff‑induced price hikes. Understanding the magnitude of the energy shock helps investors gauge sectoral exposure, from transportation to consumer discretionary, where input‑cost pass‑through could reshape profit margins.

A deeper, perhaps more consequential, factor is the demographic shift in labor supply. Net immigration, which contributed roughly 2.3 million workers in 2024, has collapsed to about 400,000 in 2025 and is expected to approach zero in 2026. Coupled with an aging baby‑boom cohort, labor‑force participation is flat, meaning the economy needs almost no net job creation to keep unemployment steady. This structural change erodes the Fed’s historical reliance on robust payroll growth as a buffer against inflation, forcing policymakers to monitor job‑finding rates and labor‑market slack more closely than headline employment numbers.

Policy implications hinge on the trajectory of the Strait of Hormuz. If shipping lanes normalize, energy prices should recede, allowing the Fed to "look through" the current inflation spike and focus on a gradual rate‑cut strategy once labor weakness becomes evident. Conversely, a prolonged closure could embed higher energy costs into broader price indices, elevate long‑term inflation expectations, and compel the Fed to keep rates higher for longer to protect its price‑stability mandate. Market participants should therefore watch oil‑price futures, Treasury inflation‑protected securities, and real‑time labor‑turnover data to anticipate the Fed’s next move.