Economists: Inflation Impact Likely Fleeting, but Tariffs Could Reshape Fed’s Rate Path
The return of “Tariff Man” has sparked reactions in global markets, with President-elect Donald Trump reviving his tough-on-trade stance. On Monday night, Trump pledged to impose a 25% tariff on imports from Mexico and Canada and an additional 10% on Chinese goods. This announcement follows his first-term strategy, where tariffs frequently dominated market narratives.
While the Mexican peso and Canadian dollar saw declines, broader U.S. markets reacted with surprising calm. Ian Lyngen, a rates strategist at BMO Capital Markets, noted that markets had largely priced in Trump’s trade priorities, given his campaign rhetoric. “The response suggests an acknowledgment that tariffs tend to have a one-time inflationary impact,” Lyngen said.
Market Reactions
Treasury yields fluctuated in response to the news. The 10-year Treasury yield briefly rose following Trump’s announcement but stabilized after a positive consumer-confidence report. Stocks were relatively unfazed, with the S&P 500 and Nasdaq Composite posting modest gains, while the Dow Jones Industrial Average edged lower after a record high.
Trump’s tariffs could elevate short-term inflation by making imports more expensive, shifting demand toward domestic production or untaxed foreign goods. Economists at Oxford Economics highlighted the potential for these policies to suppress growth in both the U.S. and affected countries. Evidence from the U.S.-China trade war indicates that for every 1% rise in tariffs, Chinese imports to the U.S. dropped by 2.5%. However, the broader inflationary effects were muted, as retailers absorbed costs and consumer demand adjusted.
Impact on Fed Policy
The inflationary effects of tariffs may prompt the Federal Reserve to reassess its monetary strategy. While recent rate cuts aimed to support economic growth, further inflationary pressures could deter additional easing. Carl Weinberg and Rubeela Farooqi of High Frequency Economics suggest the Fed might pause or halt rate cuts to evaluate the economic impact.
“The Fed’s response will depend on how these tariffs influence prices and economic stability,” they noted, adding that any prolonged inflation could reduce real incomes and GDP growth, especially if paired with sustained higher interest rates.
Uncertain Tariff Trajectory
Despite the bold announcement, questions linger about the longevity of these tariffs. Analysts suggest they might serve as leverage in broader negotiations. Trump tied the tariffs to curbing illegal immigration and drug trafficking, leaving room for affected nations to respond with policy changes to avoid the levies.
Stephen Brown of Capital Economics remarked, “This mirrors Trump’s 2019 approach with Mexico, where threats were withdrawn after concessions were made. The market’s muted reaction reflects uncertainty about whether these tariffs will materialize or evolve into broader trade agreements.”
For now, markets appear to be waiting for more clarity, as investors weigh the potential short-term inflationary impacts against longer-term economic consequences.
