We Have a Credibility Issue
Posted on March 31, 2025 in Fiscal Policy
The tariff actions and threats continue to mount, and they are having a highly predictable impact on inflation expectations. Both market-based and survey-based estimates of inflation expectations are telling the same tale: people expect that the draconian tariffs now being imposed on our closest trade partners will lead to higher prices. What’s more, the survey and market data are not telling us that the impact on prices will be one-off or “transitory” as the new presidential administration has suggested. Rather, the data are saying that the inflation threat will persist over a longer period of time. In my view, investors and survey respondents are worried about President Trump’s unpredictable negotiating style. There is simply no way to predict what’s coming next, nor whether any decisions being made will be definitive. In other words, even if the administration is successful in crafting new trade agreements with Canada, Mexico and China, who’s to say that the President won’t change his mind next year if and when he decides that the agreements no longer meet his needs? It’s this uncertainty or lack of transparency that negatively impacts decisions to spend and invest and therefore economic activity. While keeping everyone off balance is the President’s preferred modus operandi, it’s hard on markets and hugely stressful for clients.
| Rising inflation expectations are important for investors because they affect monetary policy decisions, and monetary policy affects interest rates and economic growth. Thus far, Fed Chairman Jay Powell appears as though he does not want to overreact to any tariff-related price increases. During his most recent press conference, he appeared to accept the notion that any tariff-related price increases would be more one-time in nature. He even used the now-taboo word “transitory.” But how can Powell have any more confidence than anyone else that President Trump won’t scrap new trade agreements the way he is scrapping United States-Mexico-Canada Agreement (USMCA), which he negotiated in his first term? Will the next trade deal be any more secure than the last one, or will our good friends to the north and south be subject to a constant state of insecurity? Markets hate uncertainty, and that’s one thing we currently have in abundance. Investors, businesses, consumers, and trade partners want to know where the goal posts are and that they won’t be constantly moved by the referee. I mentioned in my last couple of Market Commentaries that I didn’t think the 25% tariffs on Canada and Mexico would be in place very long because they are too destructive. This is still my base case, but my confidence is somewhat eroded. |
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