Since the tariffs were announced earlier this year, we’ve seen US inflation data mostly come through below expectations.

Since the tariffs were announced earlier this year, we’ve seen US inflation data mostly come through below expectations. Implied inflation expectations from the bond market have eased down as well, and the labour market has weakened. To cap it all, we’ve seen one Fed Governor, Waller break ranks and call for a rate cut at next week’s meeting. It is almost as if tariffs never happened. But they did and, in addition to the 10% baseline tariff and the much higher tariffs on products such as steel and autos, many countries face a steep increase in their tariff rates from next month. Surely all of this is likely to lift inflation.

Of course, economists are anticipating higher inflation but if we look at the survey of some 50 US economists in the Bloomberg survey, we see that the median forecast is for CPI inflation to peak at around 3.3% in Q4 and end 2026 at around 2.5%. Given that the current rate is 2.7% that’s not much of an impact from tariffs, either in terms of their first-round effect or the possibility of second-round effects.

Steven Barrow, Head of Standard Bank G10 Strategy, said inflation would easily scale 4% in the coming year and is still likely to be north of 3% next year. Now that’s not on a par with what we saw in 2022 when CPI inflation reached a peak of 9.1%, but it is sufficiently higher than most expect to imply problems for both the bond market and the US dollar, especially if the Fed is pressed into injudiciously rapid rate cuts by political pressure.

So why do we see upside risks? In Steven Barrow’s opinon, the first reason is easy. It is that tariffs lift prices. That’s the theory and the historical evidence. Defenders of tariffs say that President Trump’s tariffs in 2018 did not lift inflation materially, but that was because tariffs were directed at China and much of the price effect was diminished by a re-routing of exports through other Asian nations. That can’t happen this time as the tariffs are universal. They are also substantially higher than back in 2018 when Trump started his tariff crusade.

Even by the time Trump started his second crusade this year the average effective tariff rate was still under 3% but, from next month the rate could be somewhere in the vicinity of 15%, or more. Simulations tend to suggest that this will produce more inflation than most expect, perhaps because many economists and investors think the tariffs will be significantly scaled back.

A second point is that the inflation surge in 2022 has made consumers and businesses more sensitive to the inflation backdrop. Consumer inflation expectations have soared on a number of measures that were quite static during the 2022 inflation episode. For instance, the 5-10 year inflation expectation in the University of Michigan survey hardly budged during the 2022 inflation episode but has soared from 3% to over 4% so far this year before easing a bit. Firms too are sensing significant price pressures with the 6-month forward inflation survey in the Philadelphia Fed report now close to the levels seen at the height of the 2022 inflation episode. In short, people seem more primed to think that inflation can rise after the 2022 surge and, in our book that can lead to greater price pressure.

Other factors Steven Barrow would point to include the fact that the Fed’s anti-inflation credibility has been set back by the 2022 episode. Of course, Powell et al have not said that any price pressure from tariffs will be transitory, which was the infamous term he used ahead of the 2022 inflation surge, but this is probably what the Fed is thinking, or at least Governor Waller. Can people trust that the Fed won’t be wrong again, especially given that President Trump is breathing down the Fed’s neck now to cut rates?

“Our sense is that inflation risks are being underplayed. We’ve already seen the US dollar and treasuries recoil when tariffs were first outlined. Prices have stabilised a bit since then but we suspect that a second downturn in the dollar and treasury prices is looming”, said Steven Barrow.