While investors remain focused on what Donald Trump might say next-whether about trade wars or geopolitics, and how that might affect the S&P 500, economists are more concerned about a different question: how these developments will affect GDP growth and, more importantly, what it means for inflation.
President Trump claims there is nothing to worry about. At first glance, it appears he may be right. March brought encouraging inflation data: CPI fell 0.1% m-o-m (vs. +0.2% in February), coming in below expectations of +0.1%. Core CPI also slowed to +0.1% (+0.2% in February), again below the expected +0.3%.
Thus, prices have fallen slightly, and core inflation has cooled. In theory, this should give the Fed room to consider rate cuts. But Fed Chairman Powell continues to hold back, speaking cautiously and saying things like, “Let's wait and see how the situation unfolds,” particularly referring to the impact of trade tensions.
And that brings us to a key point: the data we’ve seen up to now doesn’t yet reflect the impact of tariffs. The real story is still ahead. Tariffs, after all, are basically taxes on imports. And as usual, companies will try to pass those extra costs on to consumers rather than absorb the hit themselves.
Higher prices could also be due to less competition. If foreign companies find the U.S. market less attractive due to higher costs, they could reduce their presence. That would allow domestic producers to take advantage of the lower supply and raise prices just because they can.
Another factor to consider is that even if companies decide to move production to the United States, consumer prices are likely to continue to rise due to the additional costs involved: new factories, logistics, restructuring of supply chains, and so on. In addition, demand for construction equipment and materials is increasing.
A weak dollar could fuel the fire, as imports would become even more expensive, giving domestic producers more room to raise prices. Meanwhile, the U.S. dollar index has fallen to levels not seen since the summer of 2023, below 100 points. Overall, the outlook does not look very rosy.
Not surprisingly, the median inflation expectation for next year rose 0.5 percentage points to 3.6% in March, the highest level and the largest monthly increase since 2023. The silver lining? Consumers continue to view these price increases as temporary, not a lasting shock to the economy.
Why the optimism? First, there is hope that the impact will be short-lived: prices will rise and then stabilize. Second, higher import prices reduce demand from consumers and businesses, leaving them with less money to spend. That drop in demand could help ease inflationary pressure.
The problem is that Trump keeps changing the rules of the game regarding tariffs. This uncertainty forces companies to price in additional risks, which only pushes prices higher. All of this complicates the Fed's job, which will likely be forced to keep monetary policy tighter for longer than initially anticipated.