The Misdiagnosis of Inflation: Why Tariffs Are Not the Culprit

The debate over inflation drivers in 2025 has become a political flashpoint, with tariffs often cast as the primary villain. However, a closer examination of Treasury Secretary Scott Bessent's recent remarks, coupled with macroeconomic data and market reactions, reveals a more nuanced reality: the services economy-not tariffs-is the dominant force behind persistent inflation. This misdiagnosis risks distorting policy responses and investment strategies, creating opportunities for those who can disentangle politicized narratives from empirical evidence.

The Treasury's Clarion Call: Tariffs Are Not the Main Driver

Treasury Secretary Scott Bessent has consistently argued that inflationary pressures stem primarily from the services sector, not from tariffs. During an interview on Meet the Press, he emphasized that imported goods have experienced flat inflation rates, while services costs-ranging from healthcare to housing-have surged. This aligns with the administration's actions: in 2025, the U.S. rolled back tariffs on over 200 food products, including coffee and bananas, to lower consumer prices.

Bessent's stance is supported by data from the St. Louis Fed, which notes that while tariffs contributed 10.9% to headline PCE inflation through August 2025, their pass-through to consumer prices was only partial, with 35% of model-predicted price increases materializing. This suggests that tariffs, while impactful, are not the sole or even primary driver of inflation.

Market Reactions: Divergent Paths in a Globalized Economy

The market's response to inflationary pressures has varied by region, underscoring the services economy's outsized role. In Europe, the economy has weathered U.S. tariffs better than expected, partly due to a trade deal that capped tariffs at 15% and a stronger euro. The European Central Bank has noted minimal inflationary spillovers from U.S. trade policies, contrasting with the U.S. experience of "stubbornly high" inflation.

Meanwhile, Dallas Fed President Lorie Logan has highlighted that U.S. inflation remains tied to resilient consumer demand and asset valuations, even excluding tariff effects. This divergence illustrates how globalized supply chains and domestic demand dynamics complicate the inflation narrative.

Macroeconomic Misinterpretation: The Stagflation Lite Trap

The conflation of tariffs with inflation risks misallocating policy focus. A 2025 analysis from RBC Wealth Management identifies tariffs as one of five disruptors to the traditional economic cycle, contributing to a "Stagflation Lite" environment marked by low growth and moderate inflation. Tariff-driven distortions have caused large GDP swings and structural shifts in supply chains, complicating the interpretation of traditional metrics like headline inflation.

Moreover, the labor market has realigned toward sectors like healthcare, reflecting broader demographic and policy trends. These structural shifts mean that cyclical indicators may no longer reliably predict inflation, necessitating a more granular approach to economic forecasting.

Investment Risks and Opportunities in Dislocated Markets

Overreacting to politicized narratives about tariffs poses significant investment risks. For instance, the S&P 500 fell 15% in early 2025 amid tariff uncertainty but recovered 10% by year-end, suggesting markets have priced in long-term adjustments rather than short-term panic. However, sectors like durable goods-vehicles, electronics-have faced sharper price pressures due to tariffs, with core goods prices 1.9% above pre-2025 trends.

To capitalize on these dislocations, investors should prioritize diversification and downside risk management. Bonds and liquid alternatives have offset equity volatility, as seen with the BlackRock Global Equity Market Neutral Fund's performance during 2025's turbulence. Lower-volatility strategies, such as the iShares MSCI USA Min Vol Factor ETF, also offer protection against market downturns. Active strategies leveraging company-level tariff exposure data can further exploit inefficiencies in a fragmented market.

Conclusion: Navigating the New Normal

The misdiagnosis of inflation as a tariff-driven phenomenon risks misguided policy interventions and suboptimal investment decisions. By recognizing the services economy's central role and adopting strategies tailored to a Stagflation Lite environment, investors can navigate the complexities of 2025's economic landscape. As Bessent aptly noted, the path to "non-inflationary growth" lies not in scapegoating trade policies but in addressing structural imbalances and fostering affordability through targeted reforms.