() – US President-elect Donald Trump’s promise to impose heavy tariffs is expected against the three main trading partners of the United States drive up prices, which would set the stage for the Federal Reserve to stop cutting interest rates and possibly raise them instead.
In a recent speech in DallasFederal Reserve Chairman Jerome Powell said it is still too early to consider how Trump’s tariff plans would affect the US economy. Campaign rhetoric is one thing, but implemented policy is another. However, Trump says he won’t waste any time and last week threatened to slap 25% tariffs on Mexico and Canada and an additional 10% tariff on Chinese goods on the first day of his second term, January 20.
Trump’s tariffs will almost certainly drive up prices on imported goods like avocados, cars and tequila. That would affect about $1.5 trillion in products moving through North America, according to an International Monetary Fund estimate.
Wall Street has already shown some concern about the possibility of inflation picking up under a second Trump term, with bond yields gradually rising ahead of Election Day and in the weeks afterward.
On the plus side, since persistently high inflation, induced by high tariffs, would prevent the Fed from reducing borrowing costs, cash and bond investments could also retain some of their luster for a little longer.
Federal Reserve officials will develop economic models for how the U.S. economy could behave under different tariff scenarios. Two possible developments they will consider will be whether Trump’s plans, if implemented, will lead to retaliatory tariffs and whether Americans believe inflation will pick up.
That’s precisely what the Federal Reserve did in 2018, when the first Trump administration launched a wave of tariffs, slapping duties on foreign products ranging from solar panels to washing machines.
In one scenario, assuming a universal 15% tariff was retaliated against, the Fed felt it would be best to raise rates if Americans also expected inflation to rise. That was the formula the Fed used to raise rates: a trade war and scared consumers, according to a declassified 2018 Fed document detailing policy alternatives, known as the “tealbook.”
Mexican President Claudia Sheinbaum has already suggested retaliatory tariffs in response to Trump’s threat.
The Fed pays a lot of attention to Americans’ perception of inflation, but that’s not a problem right now: Americans’ inflation expectations for next year fell noticeably in November, according to the latest US consumer survey. The Conference Board, falling to the lowest level since March 2020.
Despite the brighter outlook for price increases, “consumers overwhelmingly selected higher prices as their top concern and lower prices as their top wish for the new year,” the Conference Board added.
“The current economic environment differs significantly from that of 2018, and while the wave of inflation has passed, its embers are still alive,” said Stephanie Aliaga, Global Market Strategist at JPMorgan Asset Management. “Consumer expectations [en cuanto a la inflación] “They have hovered around 3% since May 2021, half a percentage point higher than their range in 2018 and 2019.”
For now, the Fed is prepared to continue cutting rates based on current conditions. Unemployment remains low, consumers continue to spend, and inflation has slowed and is expected to slow further, despite seeing a recent spike.
Although there may not be much relief in borrowing costs in the offing.
“The economy is not sending any signal that we should rush to lower rates,” Powell said in his speech in Dallas in mid-November.
And although the Fed has begun to cut rates, mortgage rates, which track the yield on the 10-year U.S. Treasury bond, have risen since the Fed’s first rate cut, in September.
Still, Fed officials believe borrowing costs are still too high, according to recent speeches, meaning they will pursue some more rate cuts to ease their grip on the economy.
“With an economic outlook supported by a resilient labor market and solid consumer spending, the Fed remains concerned about lower-wage workers still struggling with higher interest rates,” wrote Quincy Krosby, chief global strategist at LPL Financial , in a note on Wednesday.
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