Shenwan Hongyuan: Under the impact of U.S. Tariffs 2.0, focus on long-term inflation expectations and corporate capital expenditures

According to the Zhitong Finance APP, Shenwan Hongyuan Securities published a research report stating that the "reciprocal tariffs" in the United States have been implemented, and the comparison of the strength, order, and persistence of stagnation and inflation may become the main contradiction in monetary policy and financial market performance. Currently, the upward pressure on inflation is not significant. According to statements from Federal Reserve officials, the impact of tariffs on U.S. inflation may not be reflected until June. The consumption of pharmaceuticals, clothing, new cars, and multimedia devices (computers, etc.) in the U.S. is highly dependent on imports, and the "re-inflation" risk of such goods needs to be closely monitored in the short term. In the medium term, the core factor driving service inflation remains the labor market. Long-term inflation expectations are the key factor determining whether the Federal Reserve focuses more on "stagnation" or "inflation." The Federal Reserve's capital expenditure survey and manufacturing PMI may be the best indicators to measure the short-term impact of tariffs on the economy.

Shenwan Hongyuan's views are as follows:

1. The economic principle of tariff shocks: a one-time cost shock leading to a "stagflation" pattern

From the latest data, how does Tariff 2.0 impact the U.S. real economy? 1) The upward pressure on inflation is not significant. The price of imported goods in the U.S. in March decreased by only -0.1% month-on-month, and core import prices were also weak. According to Federal Reserve officials, the impact of tariffs on U.S. inflation may not be reflected until June; 2) The current U.S. economy is still characterized by "strong reality, weak expectations," with strong performance in employment and retail in March.

The economic principle of tariff shocks: reciprocal tariffs are a one-time cost shock, similar to the public health event in 2020, leading to a "stagflation" pattern. Tariffs will raise import prices and suppress demand for imports. Higher price levels will stimulate domestic production, benefiting some competitive enterprises. Overall, due to greater losses for consumers, net welfare is negative.

2. Review: The footprints of "stagflation" in the U.S. economy during Tariff 1.0

What characteristics did tariffs have on the transmission of U.S. inflation during the Trump Tariff 1.0 period? 1) Tariffs were basically borne entirely by U.S. enterprises and consumers. The increases from Tariff 1.0 were fully transmitted to rising U.S. import prices; 2) The increases in U.S. CPI and PPI prices were gradual, and inflation was "temporary." For example, the tariff on washing machines in 2018 saw price increases last for nine months before declining.

After the implementation of Trump Tariff 1.0, the U.S. economy was most impacted in the short term in terms of corporate investment. After the three rounds of 301 tariffs were implemented from July to September 2018, the U.S. manufacturing PMI fell sharply. On the other hand, based on the Federal Reserve's statements during the Tariff 1.0 period and the historical characteristics of the U.S. economy before recessions, corporate investment is the most sensitive to tariffs and requires close attention.

3. Under the impact of Tariff 2.0, how will the future U.S. economy unfold? Focus on long-term inflation expectations and corporate capital expenditures

How to track the future inflation rhythm in the U.S., and which areas need special attention? Based on the proportion of each component of the U.S. core PCE that comes from imports, it can be observed that the consumption of pharmaceuticals, clothing, new cars, and multimedia devices (computers, etc.) in the U.S. is highly dependent on imports, and the "re-inflation" risk of such goods needs to be closely monitored in the short term. In the medium term, the core factor driving service inflation remains the labor market Long-term inflation expectations are the key factor determining whether the Federal Reserve is more concerned about "stagnation" or "inflation." Recently, Powell's remarks have shown a clear concern for the "persistence" of inflation, emphasizing that the Fed's responsibility is to maintain stable long-term inflation expectations. Currently, apart from the University of Michigan's inflation expectations, some of the Federal Reserve's published 5-year inflation expectations remain stable.

The Federal Reserve's capital expenditure survey and manufacturing PMI may be the best indicators for measuring the short-term impact of tariffs on the economy. Structurally, from the manufacturing sector perspective, as of April 9, the industries with the highest import tariff rates in the tariff version are textiles, apparel, leather, and electrical equipment. Continuous tracking of shipment volumes and order amounts is necessary to assess the impact of tariffs on economic growth.

Risk Warning

Escalation of geopolitical conflicts; U.S. economic slowdown exceeds expectations; Federal Reserve turns "hawkish" beyond expectations.