Tariffs Drive 15% Rate Hike, Fed Holds Rates Amid Inflation Fears

Bank of America has recently highlighted the significant negative impact that tariffs are having on the US economy and the dollar. The bank's analysis underscores that the tariffs implemented by the Trump administration are causing a more pronounced negative effect than initially anticipated. This assessment comes as the Federal Reserve officials have expressed concerns about the potential for higher inflation and increased uncertainty in the economy due to these tariffs.

The tariffs have created a complex situation for the Federal Reserve, as they could both raise inflation and slow down the economy, leading to higher unemployment. This dual impact has made it challenging for the Fed to determine the appropriate course of action regarding interest rates. According to the minutes from the Fed's May meeting, almost all officials saw a risk that inflation could prove to be more persistent than expected. This concern, coupled with the uncertainty surrounding trade policy, has led the Fed to hold off on any interest-rate moves while they evaluate the full impact of the tariffs.

The tariffs have also raised the average tariff rate in the US to 15%, the highest in decades, which has further exacerbated the economic uncertainty. The Fed officials have noted that the tariffs could lead to higher prices in the coming months, as companies are likely to pass on at least some of the cost of the extra duties to consumers. This price increase could be more pronounced given that the economy recently experienced the highest inflation in 40 years in 2022, making consumers more accustomed to price hikes.

The impact of the tariffs on the dollar has also been significant. The uncertainty surrounding trade policy and its potential effects on the economy has led to a more pronounced negative impact on the dollar. This is because the tariffs have created a situation where the dollar's strength is being undermined by the economic uncertainty and the potential for higher inflation. The Fed's decision to hold off on interest-rate moves has also contributed to this uncertainty, as it has made it more difficult for investors to predict the future direction of the economy.

Bank of America expects the data to be somewhat weak as policy uncertainty has led to a halt in corporate hiring and investment plans, in addition to ongoing high tariffs. Moreover, fiscal easing may push up borrowing costs. The bank believes that tariffs may trigger retaliatory measures, and since the US trades with the world on a larger scale than any other country trades with the US, it is more vulnerable to these impacts. If US economic indicators improve, investors may start to ignore policy noise and support the dollar; however, the current outlook remains uncertain.