Key Takeaways
- Talk around tariffs rumbles on but this week economic data has dominated. Is US inflation on the up and what will be the implications for interest rates?
- CPI numbers came in at 2.7% year-on-year – a figure that was higher than expected.
- For now, it remains relatively benign but appears to be settling some way above the Federal Reserve’s 2% target.
- Companies are cushioning customers from the impact of tariff associated price hikes. When stockpiled imports are used up however, higher costs will need to be passed on.
- The Federal Reserve looks set to remain in ‘wait and see’ mode but markets are currently pricing in two cuts in the remainder of 2025.
While the tariff theme continues to rumble away, this week has been all about the economic data and trying to decipher whether the tariffs are showing up in US inflation, and the consequences for US interest rates.
The economic data this week has been headlined by the latest US inflation data, which showed CPI in June accelerating to 2.7% year on year. This was higher than expected – and up from 2.4% in May. Core inflation was 2.9% and below expectations for the fifth consecutive month. Within the numbers there were some signs of upwards pressures from tariffs – household furnishings rose by 1% month on month (MoM), and toy prices were up 1.8% MoM having been up 1.3% MoM in May. Household appliance prices rose 1.9% MoM, the largest monthly increase on record. The data certainly hints at tariffs beginning to have an impact on the overall data, though this is offset by falling housing costs which have a significant impact on core CPI given that the ‘shelter’ component in the CPI basket has a weighting of almost 40%.
While US inflation remains relatively benign, it appears to be settling some way above the Federal Reserve’s 2% target, and the near-term risks remain to the upside. For now, US companies are cushioning the impact on consumers and many have said they are waiting to see where tariff levels settle before considering price hikes. Companies have some flexibility in this respect thanks to imports stockpiled earlier. But once these stockpiles are used up, higher costs will need to be passed on. If not, company margins will suffer the consequences.
For the moment, the data will leave the Federal Reserve comfortable in ‘wait and see’ mode for July and August’s CPI prints ahead of the next rate setting meeting on 17 September. By then the Fed should have more insight into the inflation pass through from tariffs and also have more data on the softening labour market. Inflation may well be headed for 3% but given their dual mandate, the Fed may well still feel the need to cut interest rates later this year.
President Trump has once again called for sizeable rate cuts, suggesting the US interest rate should be more like 1% citing ‘Very Low Inflation’. Trump suggested that one trillion dollars a year would be saved in debt costs.
Markets saw a 60-minute wobble last week as news broke that Trump had discussed sacking Powell with Congressional Republicans, one of which took to social media to claim Powell’s dismissal was ‘imminent’. An hour after the news broke, causing spikes in yields and a slump in the US dollar, Trump told reporters in the White House it was ‘highly unlikely’ he would imminently fire the Fed Chair but didn’t rule it out. Trump said ’we’re not planning on doing anything…. I don’t rule out anything but I think it’s highly unlikely, unless he has to leave for fraud, and it’s possible there’s fraud’. This is a reference to the ‘scandal’ some Republicans are pushing over the escalating costs of the refurbishment of the Federal Reserve building in Washington.
Clearly Trump wants Powell out, but he remains hesitant to fire him. The political theatre continues but any perception of loss of independence at the Fed will not go down well in bonds and the dollar. Equities could ultimately find the positives in the potential for lower rates under a more Trump-leaning Fed Chair. Ultimately, we will see a newly appointed Fed Chair next year, and this person will inevitably be more Trump friendly. For now, futures markets are pricing just under two rate cuts, a total of 43 basis points, for this year. As recently as April, markets were pricing 100 basis points of rate cuts this year. So expectations have shifted on the path of rates, and we may well be in a holding pattern until we get more conclusive evidence on the size of the impact of tariffs on the CPI data.
The US effective tariff rate – the average rate charged on imports – has varied between 2.5% and 26.5% so far this year, after decades below 5%. Where we end up on this wide scale, and any retaliation that follows, will have a significant role in determining the impact on the US economy and the path for interest rates going forwards.
