A year of surprise
Every year brings its share of surprises that have varying consequences for financial markets and investors. One might be tempted to consider the trade war as one of 2025’s most significant surprises, but perhaps this would be a mistake. Media headlines may be giving considerable attention to the economic policies of the Trump administration, but their impact remains difficult to discern in financial markets or nominal growth figures.
The initial reaction to Trump's election was to sound the inflation alarm and highlight growth risks. During the first quarter, Simply put used long-term data series in our estimation that the tariff rates at that time might temporarily increase US inflation by 1.5% and reduce real growth by 0.9% over the year. Yet, there has so far been no trace of this slowdown in economic data, and even less in financial markets. Have ‘risk-based’ investors been misled by a truly different situation? That's not yet certain.
At this stage, the real surprise has been the minimal impact of tariffs on the real and nominal economy – something markets were quick to perceive. This week, Simply put questions whether this absence of economic consequences can persist during the second half of the year.
Read more: Are investors underestimating fundamental risks?
It's all about inventories
As discussed previously, inventories are playing a crucial role in the tariff drama and should not be overlooked. Their role is twofold
- Companies strategically ‘restocked’ prior to the tariff implementation and during the negotiation phase, which was accompanied by a global rate of 10% (excluding China)
- This rapid restocking could subsequently impact both inflation and growth. By ‘importing’ a portion of future demand, precipitous restocking creates a demand shock, artificially inflating growth and leading to price adjustments – or inflationary pressures (wink wink Federal Reserve Chair Jerome Powell).
Figure 1 shows the recent evolution of inventory values in the US compared to Europe. This graph is essential for understanding the consequences of White House policy. When tariffs were announced during the first quarter, European companies did not collectively react. However, in the US, businesses quickly understood they would soon pay more for inputs, generating increased demand to replenish inventories. The behavioural divergence is evident in the graph and should raise questions about the consequences of these artificial restocking periods. After all, in 2025, restocking in the US is comparable to what followed the end of the pandemic. It is unlikely to be sustained and affects only a single economy, but this graph must keep Jerome ‘too late’ Powell awake at night because he may actually be ‘too early’.
FIG 1. Changes in eurozone and US inventories1
Read more: Multi asset: resilience in a V-shaped market recovery
The inventory-inflation connection
The relationship between inventories and inflation is almost as old as time itself – J Kitchin2 was among the first to observe that economic activity, inflation and inventories were interconnected. The nature of their relationship forms relatively short cycles, typically 40 months (3 to 5 years). These cycles differ from the economy's more natural cycles, such as the Juglar (business cycle) or the Kondratieff (innovation cycle), and are based on the following premise: strong demand leads to inventory formation, and this extraordinary inventory creation introduces upward pressure on input prices, generating inflation. Once inventories become excessive, destocking occurs, slowing production and economic activity, leading to moderated price growth. As an illustration, Figure 2 shows how inventories and inflation have moved hand in hand since the 1950s.
FIG 2. Inventories and prices - 12-month variations3
This graph clearly shows that inventory restocking phases generally occur in an inflationary context, as in the 1970s, 2006-2007 or 2021, while inventory collapses tend to happen during periods when inflation is in retreat. When considering inventories in relative variation, as shown in Figure 2 (Figure 1 presents them in absolute variation), we understand that inventories growing by more than 20% generally come with exploding inflation.
Fortunately, this is not currently the case. But restocking is nevertheless proceeding at a good pace, and we can assume that it has not occurred uniformly across activity sectors and production stages.
What exactly is being restocked?
As the tariffs were announced in a disorderly fashion, they sometimes affected pharmaceutical products, sometimes the auto industry, or certain raw materials; therefore, we can assume that price increases won't be uniform. Pessimists might even point out that since these restocking phenomena aren't even consistent across the US but specific to certain sectors, they cannot generate inflation: inflation is the general rise in price levels, not a rise in certain prices. Setting these objections aside, Figure 3 presents inventory growth rates by activity and product type during the first quarter.
As already shown, all products experienced restocking. However, it has not been uniform across the board. Durable consumer goods saw a marginally more pronounced inventory reconstitution than non-durable consumer goods. However, this product-based segregation does not appear to produce significant discrimination.
When segregating by activity type, the conclusion becomes markedly different: retail sales reduced their restocking, wholesale sales marginally exceeded their restocking habits, but manufacturing activity did most of the restocking. Thus, it's primarily upstream industries in the production process that replenished their inventories.
So we can conclude that as US restocking occurred in upstream industries, and at the beginning of the tariff implementation phase, inflation could be localised in the upstream stages of the production process. With Q2 GDP figures, we should learn more about inventory dynamics in the downstream strata of production and if these could become a source of inflation worthy of the Fed’s concern.
FIG 3. Growth rates of inventories by product and business types4
The investment implications for multi-asset investors
This analysis raises the question of whether US inflation is totally behind us. Maintaining exposure to assets that hedge against this risk still makes sense. Trends in commodities remain positive, encouraging us to maintain a marginally greater exposure to this asset class. Inflation risk remains significant for an investment world that continues to be US dollar-centric. In addition, while the trade war seems to have been largely dismissed by global markets, our risk model still bears some of its scars, suggesting complacency may hide enduring risks. Diversification has rarely been so badly remunerated than in recent years, yet it has rarely seemed as relevant to investors than now.
Simply put, tariffs have not yet been inflationary due to the complex mechanisms of inventories, but the situation could change in the coming months.
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 is designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- From the beginning of this month, our growth nowcaster has risen globally, particularly due to improvements in monetary conditions in the US. In China, the signal has decreased
- Our inflation indicator remained unchanged this week, with a slight decrease in the eurozone
- The monetary policy signal for the US offsets the one for the eurozone. The deterioration in US employment led to a decrease in the indicator, while the opposite situation in the eurozone resulted in an increase.
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 gather 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).
