At this stage, much of President-elect Donald Trump’s anticipated fiscal policy largely borrows from the deregulation playbook of Ronald Reagan – except for his willingness to make the rest of the world finance the US Treasury's shortfall. Markets expect the blanket 10% tariffs he has pledged to impose will exert two effects. First, import quantities would decline, weakening growth among exporting countries. Second, as the prices paid by US consumers for imported goods rise, inflationary pressures would become resurgent. This week, Simply put assesses whether Trump’s tariffs would be inflationary after all.
The immediate impact
It's a familiar chain of thought: because tariffs increase import prices, they either raise the cost of production, consumer prices (or both), stoking an inflation shock. G10 countries' recent struggles with inflation no doubt justifies concerns about an all-too-soon return of the bogeyman. Anticipating the potential outcomes of a uniform 10% tariff can be approached in two ways: analysing the immediate effects of higher import prices on domestic inflation, and the longer term impacts as they are dynamically integrated into the complex system of an economy.
Focusing on the immediate effects (see Figure 1), we find two insights:
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1
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Data from Trump’s first term, characterised by a US-China trade war, enables us to observe the effect of tariffs on consumer prices. It shows that the inflationary effects probably undershot expectations: while import prices increased by an average of 1% per year from 2005-2024, they rose 0.4% per year from 2017-2020. Within these averages, some goods categories experienced higher increases – such as textiles, which climbed 1.6% from 2017-2020 and 1% during the longer period. Inflation was more moderate during Trump's first term, with prices rising by 1.8% per year despite an inflation shock between mid-2016-2018. From 2005-2024, the average inflation rate was 2.3%
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2
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Apart from imports of processed commodities, the ‘beta’ of US inflation to import prices is relatively low at about 0.1. From this, we can infer that a 10% increase in tariffs can result in a 10% increase in import prices, therefore potentially adding about 1% to US inflation, all other things being equal.
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Such an immediate effect is only a measure of the direct impact of a tariff hike and omits the role that the US dollar plays in these international transactions can play. We assess this next.
FIG 1. Realised inflation during the 2005-2024 and 2017-2020 periods (left) and historical ‘beta’ of consumer prices to import prices (right)1
The US dollar's ridge
A more comprehensive, and complex, analysis considers the functioning of a higher tariffed US economy over time. All things do not remain equal and it's probably in such longer-term economic movements that we can find answers to the imported-inflation puzzle.
These mechanical aspects are presented in Figure 2. The three graphs simulate a 10% shock on US import prices, estimated from a simple vector autoregressive model over the 1990-2024 period. This model is estimated by incorporating the effect of US dollar fluctuations: when inflation rises, and if there is an overall knock-on effect, the Federal Reserve has historically been tempted to respond by raising rates. In doing so, the US dollar's value increases and leads the US to import deflation.
Our estimates show that this effect removes approximately 30 basis points in the two-to-three quarters after the shock. To take this into account, we would subtract 0.3% from the instantaneous increase of 1%, resulting in a total effect of 0.7%. This rise in inflation, considered independently, should not frighten investors: spread over four years, we're talking about less than 20 bps of inflation per year. The question pending is, of course, the impact of higher tariffs on global and US growth – a matter we will address in the near future.
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FIG 2. Simulated effect of a 10% tariff increase on import prices2
What this means for All Roads
Our investment signals keep steering us towards neutrality – both in terms of global market exposure and portfolio composition. They indicate the inflation question is not totally resolved, and our trend signals direct us away from government bonds although while risk conditions are normalising for fixed income at large, albeit at a slower pace recently. Overall, our current market exposure remains close to its long-term level, in response to inflation risks that persist but are less severe than in 2022.
Simply put, a uniform hike in US tariffs alone is unlikely to create a domestic inflation wave in 2025 – but it could contribute to one.
To learn more about our All Roads multi-asset strategy, click here.
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- Our growth signals continue to show signs of strength, with 54% of data indicating improvement over the past month
- Inflation is the main risk highlighted by our signals and is currently concentrated in the US
- Despite stronger growth and inflation data, monetary policy remains dovish course among major central banks.
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicator gathers economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
