Trump’s Tariff Macroeconomics
While the long-term outlook for the US economy is still likely to encounter many more twists and turns, market-based measures of inflation, such as the breakevens, are suggesting that a disinflationary effect could be taking place as a result of Trump’s announcement of sweeping global tariffs on imports, subject to a 90-day delay.
Inflation breakevens, which are derived from the yields on traditional Treasury bonds and Treasury Inflation-Protected Securities (TIPS), pointed to a peak five-year breakeven inflation rate of 2.6% in early February but have since fallen to 2.32%.
Likewise, the 10-year breakeven rate has fallen from 2.5% to 2.19%, while the Federal Reserve Bank of Cleveland’s expected two-year inflation rate has held at around 2.6%.
While tariffs are generally viewed as inflationary measures due to higher import costs often being passed on to consumers, unchanged income levels among consumers point to lower consumption rates and the prospect of price declines in the cost of living.
With interest rates closely linked to inflation, we may see weakening consumer sentiment pave the way for a disinflationary environment that allows the Federal Reserve to lower interest rates, helping the President to bring what he saw as frustratingly high borrowing costs.
Calm Before the Storm?
Despite Trump’s victorious stance on inflation, the long-term impact of the United States’ tariffs could cause more inflationary pressures over the months ahead.
John Williams, president and CEO of the Federal Reserve Bank of New York, recently lowered his outlook for the US economy off the back of Trump’s tariffs in a warning sign for possible stagflation ahead.
Williams has stated that he expects economic growth in the US to slow in 2025 to ‘somewhat below 1%’ while inflation increases to somewhere between 3.5% and 4%.
There’s also evidence of fiscal strain elsewhere in the world that could provide an insight into what the future holds for the United States.
The Reserve Bank of Australia announced that interest rates would be held at 4.1% in April, and its meeting minutes warned borrowers against expecting deeper rate cuts in the wake of escalating trade tensions.
The minutes suggested that weaker global demand and the possibility of trade diversion from the US could reduce inflation domestically, but a larger exchange rate depreciation or more substantial global supply disruptions would instead increase inflation.
This possible outcome could have a knock-on effect for the United States and may point to a more negative outlook for inflation in the future.
According to James Knightley, ING’s chief international economist, the price of goods will ‘inevitably’ increase in a move that he expects to push inflation above 4%, along with some service price rises such as insurance. However, the shelter components, which account for 35% of the inflation based on weight and over 40% in terms of core inflation, will come under downward pressure later in 2025.
Knightley points to the Cleveland Fed’s falling measure of national new rent agreements as an example of the weaker consumer spending power that’s set to impact the United States’ economic performance. As a result, the economist anticipates that interest rates will remain unmoved until more meaningful cuts resume in Q3 2025.
Consumers to Decide the Fate of Inflation
As always, consumers will have the final say on which inflation projections are correct. Trump’s protectionist approach to the economy and the potential of a global trade war have placed economists in uncharted territory in terms of what’s to come in 2025.
With US consumers wary of the macroeconomic consequences of tariffs, the higher costs of imports may be less inflationary than first feared. What this means for growth on Wall Street, however, is anyone’s guess.
