Tariffs’ Impact on Economy and Bond Markets

Although tariff negotiations continue, deals are being made, shifting investor focus on assessing the fallout. Our Global Head of Fixed Income Research and Public Policy Strategy Michael Zezas and Chief U.S. Economist Michael Gapen consider the ripple effects on inflation and the bond market. 

 

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy. 

Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist. 

Michael Zezas: Today, how are tariffs impacting the economy and what it means for bond markets? 

It's Wednesday, August 13th at 10:30am in New York. 

Michael, we've been talking about how the near-term uncertainty around tariff levels has come down. Tariff deals are, of course, still pending with some major U.S. trading partners like China; but agreements are starting to come together. And though there's lots of ways they could break over time, in the near-term, deals like the one with Europe signal that the U.S. might be happy for several months with what's been arranged. And so, the range of outcomes has shrunk. 

The U.S.' current effective tariff rate of 16 percent is about where we thought we'd be at year end. But that's substantially higher than the roughly 3 percent we started the year with. So, not as bad as it looked like it could have been after tariffs were announced on April 2nd, but still substantially higher. Now's the time when investors should stay away from chasing tariff headlines and guessing what the President might do next; and instead focus on assessing the impact of what's been done. 

With that as the backdrop, we got some relevant data yesterday, the Consumer Price Index for July. You were expecting that this would show some clear signs of tariffs pushing prices higher. Why was that? 

Michael Gapen: Well, we did analysis on the 2018-2019 tariff episode. So, in looking at the input-output tables, which give you an idea of how prices move through certain sectors of the economy, and applying that to the 2018 episode of tariffs – we got the result that you should see some tariff inflation in June, and then sequentially more as we move into the late summer and the early fall. 

So, the short answer, Mike, is a model based plus history-based exercise – that said yes, we should start seeing the effects of tariffs on those categories, where the direct effect is high. So that'd be most of your goods categories. Over time, as we move into later this year or early next year, it'll be more important to think about indirect effects, if any. 

Michael Zezas: Got it. So, the July CPI data that came out yesterday, then did it corroborate this view? 

Michael Gapen: Yes and no. So, I'm an economist, so I have to do a two-handed view on this. So yes… 

Michael Zezas: Always fair. 

Michael Gapen: Always, yes. So, yes, core goods prices rose by two-tenths on the month, in June they also rose by two-tenths. Prior to this goods’ prices were largely flat with some of the big durables, items like autos being negative, right? So, we had all the give back following COVID. So, the prior trend was flat to negative. The last two months, they've shown two-tenths increases. And we've seen upward pressure on things like household furnishings, apparel. We saw a strong used car print this month, motor vehicle and repairs. So, all of that suggests that tariffs are starting to flow through. 

Now, we didn’t – on the other hand – is we didn't get as much as we thought. New car prices were flat and maybe those price increases will be delayed until models – the 2026 models start hitting the lot. That would be September or later. And we didn't actually; I said apparel. Apparel was up stronger last month. It really wasn't up all that much this month. So, the CPI data for July corroborated the view that the inflation pass through is happening. 

Where I think it didn't answer the question is how much of it are we going to get and should we expect a lot of it to be front loaded? Or is this going to be a longer process? 

Michael Zezas: Got it. And then, does that mean that tariffs aren't having the sort of aggregate impact on the economy that many thought they would? Or is maybe the composition of that impact different? So, maybe prices aren't going up so much, but companies are managing those costs in other ways. How would you break t