Trump's Tariffs: A Potential Inflation Trigger for Fed Rate Hikes

As President-elect Donald Trump prepares to take office, his proposed tariffs on Mexico, Canada, and China have raised concerns about their potential impact on inflation and, consequently, the Federal Reserve's interest rate policy. In an interview, Brian Moynihan, CEO of Bank of America (BNY), suggested that the Fed could hike rates if Trump's tariffs unleash inflation. This article explores the potential consequences of Trump's tariffs on inflation and the Fed's decision-making process.



The Impact of Tariffs on Inflation

Tariffs are a tax on imported goods, which can lead to increased prices for consumers. In 2018, the U.S. International Trade Commission found that the tariffs imposed by the Trump administration increased prices between 1.7% and 7.1% in the ten most affected sectors, including apparel, car parts, furniture, and computer equipment. If Trump's proposed tariffs are implemented, they could further increase prices for consumers, contributing to higher inflation.



Consumer Expectations and Inflation Perceptions

Consumer expectations and perceptions of inflation play a significant role in the Fed's decision-making process. In 2018, when the Trump administration imposed tariffs on various foreign goods, the Fed analyzed different scenarios to determine the appropriate policy response. One scenario assumed retaliation against a 15% universal tariff, in which case the Fed deemed it best to raise rates if Americans also expected inflation to pick up (Fed document, "tealbook"). This suggests that the Fed is sensitive to both the actual inflationary impact of tariffs and consumers' perceptions of inflation.

Currently, Americans' expectations for inflation in the year ahead have declined, reaching the lowest level since March 2020 (The Conference Board's consumer survey). However, consumers still overwhelmingly selected higher prices as their top concern and lower prices as their top wish for the new year. This indicates that consumers remain vigilant about inflation, even as their expectations for future price increases have decreased.

Stephanie Aliaga, global market strategist at JPMorgan Asset Management, notes that consumer expectations for inflation have hovered around 3% since May 2021, which is half a percentage point higher than their range in 2018 and 2019. This suggests that consumers' inflation expectations have shifted upward over time, potentially reflecting a higher baseline for inflation.



The Fed's Decision-Making Process

In light of potential retaliatory tariffs, the Fed will likely consider how these tariffs might affect consumer perceptions of inflation and, in turn, how those perceptions might influence economic behavior. If consumers expect inflation to rise due to retaliatory tariffs, they may adjust their spending and saving habits, which could further impact inflation rates. By considering these factors, the Fed can make more informed decisions about interest rate policy and help maintain price stability in the economy.

In conclusion, Trump's proposed tariffs on Mexico, Canada, and China could potentially impact the overall inflation rate in the United States, influencing the Fed's decision to hike or lower interest rates. The Fed will likely consider the actual inflationary impact of tariffs, as well as consumer expectations and perceptions of inflation, when making its decision. As Brian Moynihan, CEO of Bank of America, suggested, the Fed could hike rates if Trump's tariffs unleash inflation, but it will ultimately depend on the extent to which tariffs affect the economy and consumer behavior.