Last week, we said that our “no recession” call was hanging by a thread amid the tariff onslaught. This week, a new lifeline has appeared in the form of a 90-day delay in reciprocal tariffs on countries other than China. We welcome it. But it is not enough. The further increase in US tariffs on China (to 145%) and retaliatory Chinese tariffs on the US (125%) is no “joke”; it is very serious business, but not good business. We argued that the April 2 tariffs were unsustainable, and we argue the same here. There are many valid grievances that the US has vis-à-vis China’s trade practices. However, imposing tariffs of this magnitude goes far beyond making the point; it actually diminishes it. And so, we look forward to a near-term de-escalation so that meaningful negotiations can unfold. At the end of the day, the world needs the US, the US needs the world, and we all need trade.
The trade disputes are souring consumers’ mood and killed the joy that the good March inflation report would have otherwise brought. The preliminary University of Michigan consumer sentiment index hit its lowest level since June 2022, with declines described as “pervasive and unanimous across age, income, education, geographic region, and political affiliation”. We’ve said it before, and it warrants saying it again: consumers don’t like tariffs. The expectations component has now plunged about 30 points since November and is back to mid-2022 levels. By contrast, inflation expectations have skyrocketed to multi-decade highs. Short-term (1-year) inflation expectations surged another 1.7 percentage points (ppt) to 6.7% and are up 4.1 ppt since November. Last time they were this high was 1981! Long term (5-10) year inflation expectations rose 0.3 ppt to 4.4% and are up 1.2 ppt since November.
These readings are troublesome but must also be put in perspective. The tariff schedule as initially announced (and even as it stands currently vis-à-vis China) represents a price shock of historical proportions. It is quite likely that manufactured goods prices would increase notably. However, consumers may we overweighting goods in their overall assessment of inflationary pressures and may discount disinflationary pressures developing elsewhere (e.g., energy, discretionary services). Still, the Fed will not like this. Comments from Fed officials make it clear the FOMC is on high alert both for softer growth and for higher inflation. Investors, which at the height of the tariff drama had priced it more than four Fed cuts this year, have scaled back those bets to just three. This remains our call and we still look for the next cut in June. Despite the tariff threat (which could also be much diminished by then if negotiations prove productive), the Fed should the benefit of two-three months of relatively benign inflation data that could coalesce support for lowering rates further, especially if evidence also builds of softening labor demand.
Normally, an inflation report as good at the March one would bring lots of cheer to investors. This week, it seems they barely spared it a glance. Overall consumer prices eased incrementally, and core consumer prices rose just 0.1% such that headline CPI inflation moderated four tenths to 2.4% and core inflation eased three tenths to 2.8%. These were the best readings since September 2024 and March 2021, respectively. Despite higher food prices, energy brought considerable relief (more to come in April) and discretionary services were tame. We expect to see softer demand for discretionary purchases as consumers seek to offset higher tariff-induced prices. Importantly, some of this could manifest even in non-discretionary areas like housing. It was good to see rent of shelter inflation ease three tenths to 4.0% y/y, the lowest since November 2021. We expect to see further moderation to the low 3.2-3.3% range by year end.