Inflation Warning: How Will Trump Play the Tariff Card?

The "hot" inflation may make Trump's "playing cards" hesitant. On February 12 local time, the United States announced that the January CPI rose unexpectedly, with not only food and energy prices remaining strong, but also a significant increase in the month-on-month growth rates of core goods and core services. Fortunately, Trump's previously announced plan to sign "reciprocal tariffs" on Tuesday and Wednesday was delayed, cleverly avoiding the CPI data and not adding "fuel to the fire" in the market. The dollar and U.S. Treasury yields rose within two hours after the CPI was released, but then retreated.

Not only is the CPI rising, but the rebound in residents' inflation expectations also sounds the alarm for Trump's policy decisions. In January, the one-year resident inflation expectation in the University of Michigan survey surged from 3.3% to 4.3%. The inflation expectation surveys from the New York Fed and the Cleveland Fed are also on the rise. Under the current fiscal pressure, the U.S. government has a strong demand to lower long-term interest rates, thus policy decisions need to be more cautious; if interest rates continue to rise, it will create significant downward pressure on the economy (Figure 4).

Is inflation "binding" the hands of tariffs? There are divisions within Trump's team: some hold a more moderate stance on trade and immigration, emphasizing the protection of GDP and the U.S. stock market as "economic growth advocates"; others stress the need to reshape the global trade landscape as "economic nationalists." Trump seems to be weighing the balance between the two, and under the current inflation situation, it may not be appropriate to tilt the scale towards the latter.

How will the "reciprocal tariffs" be advanced? The White House stated on Wednesday that Trump may announce the "reciprocal tariffs" plan before meeting with Indian Prime Minister Modi on Thursday. We believe that in terms of content arrangement, more room for adjustment may be left for the other countries. For example, in trade between the European Union, India, and the United States, the tariff rates imposed by the United States are significantly lower; if the European Union and India are willing to proactively lower their tariff rates on the U.S., facilitating the entry of U.S. goods into the market, the U.S. may also provide corresponding dynamic adjustment mechanisms, or even exemption mechanisms.

The easing of the Russia-Ukraine situation may also serve as a "bargaining chip" to alleviate inflation concerns. The CPI energy component moves almost in sync with international oil prices, so stabilizing the Middle East and international oil prices is crucial. On February 12, Trump stated that he had a "productive phone call" with Putin discussing the common desire to end the Russia-Ukraine issue and the possibility of a meeting.

What potential impact do Trump's announced tariff plans have on inflation?

1. 25% Tariff on Canada and Mexico (postponed to March 4)

From the perspective of the supply structure of domestic demand in the United States, textiles/apparel, computers and electronics, furniture, motor vehicles and parts, crude oil and natural gas are highly dependent on foreign sources, thus their prices are significantly affected by tariffs. Among these, the proportion of goods from Canada and Mexico is particularly high in imports of crude oil, natural gas, motor vehicles, and parts. The deep integration of the U.S., Mexico, and Canada industries requires multiple cross-border production processes, and the price impact is also a cumulative effect of the "25% tariff." The comprehensive tariffs on Canada and Mexico have a significant impact on the selling prices of U.S. goods, and we believe that these tariffs may be downgraded or even canceled before March 4.

The expectation for the next interest rate cut by the Federal Reserve has been further postponed. Federal Reserve Chairman Powell stated on Tuesday that "the neutral interest rate has risen" and "there is no need to rush to cut rates"; Trump then called for a rate cut the next day, in conjunction with the upcoming tariffs. After the CPI was announced, the market expected the next rate cut to be in October this year. We believe that the White House currently has a strong demand to lower long-term interest rates, and controlling the signs of "re-inflation" is more urgent than reshaping the supply chain. In the short term, the rhetoric around tariffs is loud, but actual implementation may be cautious.

Author of this article: Pei Mingnan from Minsheng Macro, Source: Chuan Yue Global Macro, Original title: "Inflation Warning: How Will Trump Play the Tariff Card? (Minsheng Macro Pei Mingnan)" Report written by: Pei Mingnan SAC No. S0100524080002, Shao Xiang SAC No. S0100524080007

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