The stock markets are back at all-time high levels, growth expectations are on the rise again, and tariff fears have clearly subsided. On the surface, the skies seem clearer now than they have in a long time, especially since April and the all-consuming focus on trade wars. This is despite the fact that many countries are now left with higher tariffs on what they export to the U.S. than those announced in April, which had alarmed both markets and economists.
A major difference now is that several “deals” have been made while so-called “tit-for-tat” escalation has been avoided, which could have led to a much worse outcome and even higher tariffs. However, that doesn’t mean the tariff increases won’t negatively impact growth and inflation expectations going forward. Admittedly, Trump has secured deals with the EU, Japan, and Vietnam as he wished – deals that are one-sided and lack any “an eye for an eye, a tooth for a tooth” retaliation on American goods exported to those countries. But that doesn’t mean we should simply celebrate all the tariff revenues that are now flowing into the U.S. Treasury.
Tariffs are a form of tax. The bill must be paid by the exporter, importer, or end consumer – or shared among them. Trump’s dream scenario is, of course, that the exporter bears most of the cost, but that is unlikely. Studies by the National Bureau of Economic Research (NBER) showed that around 80–90 percent of the costs were borne by American consumers and businesses through higher prices on Chinese goods during 2018–2019 under Trump 1.0. This will have consequences for growth and inflation in the U.S.
The question is not whether the effects on growth and inflation are positive or negative, but how large those effects are. On that question, the answer is more open and varies among those trying to quantify it. Sequencing and timing will also be crucial going forward, as much has already been distorted by so-called “frontloading” by importers. This means American companies imported goods from abroad before the tariffs came into effect, thereby stockpiling to avoid higher prices.
Prices in the U.S. are likely to rise again, and there are already signs of this. This comes during a period where inflation has remained high and above the inflation target ever since the pandemic. Even if the tariff increases only provide a “transitory” and temporary boost to prices, it’s still an effect the U.S. central bank, the Fed, cannot completely ignore in its monetary policy decisions. That is if the Fed can still conduct policy as independently in the future as it has in the past.
There is little doubt that Trump wants lower interest rates. Pressure on the Fed, and especially Powell, has come in several waves and does nothing to strengthen the belief in full independence. In a Financial Times survey of 94 economists, 89 said Trump’s repeated attacks on the Fed and Powell have already weakened the central bank’s credibility. Powell’s term as Fed Chair ends in May next year, and then Trump will appoint his successor. Slightly more than half (52 percent) of the same economists believe the Fed's focus will shift after that.
Trust is something a central bank absolutely depends on—to shape expectations and ensure the inflation target is met. The question of independence is crucial, especially at a time when the U.S. national debt has only increased since the pandemic and inflation has remained above target. Speculation that the U.S. is trying to inflate its way out of the debt situation is dangerous and not a free lunch that lenders will accept without demanding compensation. The rise in long-term U.S. government bond yields and a weaker dollar may be symptoms that lenders are no longer as confident and that trust has eroded.
Tampering with independence and trust is therefore like playing with fire. Trust takes a long time to build but can disappear quickly. The U.S. has been a leading force in building trust in independent institutions since World War II and has reaped the benefits of that. It will take a lot for that to change—but it can no longer be taken for granted. There will be consequences if the Fed’s independence and credibility are further undermined.
After over seven months under Trump 2.0, we are already beginning to feel what’s being called “Trump fatigue.” Gradually, we are becoming more immune and apathetic to his statements and actions. In August, Erika McEntarfer, head of the Bureau of Labor Statistics (BLS), was fired after weak labour market figures were reported.
For a long time, we've been told not to take Trump literally. That mistake caught up with the markets in April when they failed to take his threats of sharply increased tariffs seriously enough.
It turned out he meant business.
