The Market Marches Higher. Tariff Inflation Is Not Yet a Reality.

Price increases for imported goods, such as toys and appliances, were far sharper than for goods either sourced domestically or exempt from tariffs, such as used cars and mobile phones. (RYAN COLLERD/AFP via Getty Images))

One of the central criticisms of the U.S. government’s response to the global financial crisis in 2008, and to the Federal Reserve’s decision to embark on its maiden round of quantitative easing, was that it would lead to hyperinflation.

Printing money, the critics argued, would unleash price pressures that central banks would find impossible to tame over the coming years thanks to surging asset prices, ultralow borrowing costs, and spending increases from a government unrestrained by high interest rates.

That never happened. The Federal Reserve’s balance sheet, the repository for the bonds purchased during its myriad phases of QE, as well as near-zero interest rates, went from around $925 billion in 2008 to around $7 trillion prior to the winter of 2020.

During that time, core inflation never topped 2.5% and began to spike only once supply chains were decimated by the Covid pandemic.

Investors might be similarly “Waiting for Godot”—a term coined by playwright Samuel Beckett for an anticipated event that never materializes—when it comes to tariff-related inflation.

The Bureau of Labor Statistics reported Tuesday that CPI inflation quickened by 2.7% in June, a tad faster than some early forecasts for 2.6% and ahead of the 2.4% pace recorded in May.

Stripping out volatile food and energy components, the so-called core inflation rate edged 0.1 percentage point higher, to 2.9%, again missing Wall Street’s 3% consensus.

What markets seem to be saying at the moment is that, while inflation pressures aren’t abating, they’re not accelerating in a way that causes concern.

The CME Group’s FedWatch tool is pegging the odds of a September Federal Reserve rate cut at around 55%, little-changed from a month ago, even after the core inflation uptick.

“Clearly inflation remains sticky, but it is far from changing course,” said Jay Woods, chief global strategist at Freedom Capital Markets. “The continued tariff uncertainty remains just that—uncertain.”

“If the data stays in-line with expectations then ‘the one data point at a time’ stance the Fed usually follows should take precedence over the uncertainty of tariffs and thus a cut in September,” he added.

Others, such as Seema Shag, chief global strategist at Principal Asset Management, aren’t as convinced.  “It may initially seem like there is still little sign of the tariff induced boost to inflation that the Fed has been expecting,” she said. “However, with increases in categories like household furnishings, recreation, and apparel, import levies are slowly filtering through to core goods prices.”

Digging in a bit more deeply into the data, meanwhile, reveals what Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics calls a “knockout punch to the tariff inflation deniers.” Price increases for imported goods, such as toys and appliances, were far sharper than for goods either sourced domestically or exempt from tariffs, such as used cars and mobile phones, he noted.

Tombs argues tariffs will provide a 1% lift to overall inflation, with “risks skewed toward a bigger uplift, given the threats of additional reciprocal rates from August 1, and the possibility that exemptions for goods such as pharmaceuticals and semiconductors eventually end.”

Markets aren’t acting like this is a reality, however. Benchmark 2-year U.S. Treasury note yields rose just two basis points following the inflation release, to 3.946%, and 10-year paper is holding at 4.475%. Stocks are also trading at the highest levels on record.

The latter likely reflects the continued dominance of megacap tech stocks and Nvidia’s ability to win a reprieve on export restrictions to China, but it’s notable nonetheless.

If President Trump is willing to make policy changes tied to a key piece of his business agenda, the development of artificial intelligence, he might be willing to do so on the central plank of his economic strategy, tariffs.

What’s clear for the moment, however, is that the inflation spike expected from the president’s tariff strategy simply hasn’t materialized. Tariff revenue, however, certainly has.

Rick Rieder, BlackRock’s chief investment officer for global fixed income, says companies are “holding the line on inflation” by absorbing some cost and have done “a decent job when it comes to responding to the threat of potential tariffs.”

“Pricing pressures due to tariffs may appear as time goes on, and particularly as several major regional trade disputes drag on longer than originally thought, but one shouldn’t count out the adaptability and resilience of U.S. firms to minimize the need for significant price increases,” he added.

If companies are reluctant to pass on price increases to a cautious consumer, or if they can mitigate them through technology and supply-chain tinkering, the president might rightly declare his tariff gambit a success.

Write to Martin Baccardax at martin.baccardax@barrons.com