Fed unlikely to hit 2% inflation target amid tariffs, says Fifth Third

The current economic environment is not conducive to the Federal Reserve achieving its 2% inflation target, Fifth Third Commercial Bank Chief Economist Jeff Korzenik said Thursday.

The Federal Reserve's path back to its 2% inflation goal faces mounting headwinds from tariffs and elevated energy costs, with the central bank's own policymakers split on the direction of rates.

"The economic environment doesn't lend itself to the Fed's 2% inflation target," Korzenik said on CNBC's "The Exchange." He cited the cumulative impact of tariffs as a key factor keeping price pressures above the central bank's objective.

Headline inflation stood at 3.5% in June, down 40 basis points from May but still 150 basis points above the Fed's target. Core inflation held at 2.6% year over year. Fed Chair Kevin Warsh told Congress this week the central bank has "no tolerance for persistently elevated inflation" and shares "a resolute commitment to restoring price stability." About half of the 19 Fed policymakers expected higher rates by year-end, according to the central bank's dot plot, while the other half favored holding steady or cutting.

The gap between the Fed's inflation target and actual price data carries direct consequences for monetary policy. If inflation remains sticky above 3%, the central bank may be forced to keep rates elevated — or raise them — for longer than markets anticipate. J.P. Morgan analysts expect the Fed to hold rates steady through the end of 2026, with the next move being a rate hike in the third quarter of 2027.

Tariffs Compound the Inflation Challenge

The tariff regime has introduced structural cost pressures that monetary policy alone cannot easily address. Unlike demand-driven inflation, which rate hikes can cool, tariff-driven price increases act as a supply-side tax on imported goods, raising costs for businesses and consumers regardless of the interest rate environment. The previous round of tariff escalation in 2018-2019 reduced bilateral trade between the U.S. and China by an estimated $50 billion over 12 months, according to Census Bureau data, while doing little to alter the trajectory of core inflation at the time.

Energy markets add another layer of complexity. Oil prices have whipsawed since the beginning of the Iran conflict, and even after a supposed ceasefire agreement, tensions remain elevated. Energy is the single biggest driver of headline inflation, and the Fed's tools are poorly suited to address price shocks driven by geopolitics rather than domestic demand.

What This Means for the Rate Path

The Fed's current policy rate stands at a level that, under normal conditions, would be considered restrictive. But with tariffs adding 0.5 to 1 percentage point to core inflation estimates from some economists, the real policy stance may be less tight than it appears. Overnight index swap markets have yet to fully price in the risk of a rate hike, though Warsh's hawkish tone this week — combined with the split in the dot plot — suggests the balance of risks is tilted toward tighter policy.

The last time a Fed chair used language as definitive as "no tolerance" on inflation was in 2022, when Jerome Powell's Jackson Hole speech preceded a cumulative 300 basis points of rate increases over the following 12 months. While the current environment is different — inflation has fallen from its 9.1% peak in June 2022 — the persistence of above-target readings suggests the final mile of the disinflation journey may be the hardest.

For investors, the implication is clear: the "higher for longer" rate narrative that dominated 2024 and 2025 may extend well into 2027. Rate-sensitive sectors — housing, utilities, and small-cap equities — face continued headwinds, while bond yields are likely to remain elevated as the market reprices the probability of future rate moves.

This article is for informational purposes only and does not constitute investment advice.