Potentially Overestimated U.S. Tariff Inflation

The current tariffs are not comparable to those in 2018 on multiple dimensions: first, the comprehensive tariffs have led to significant financial deflation (lowering profit expectations, eroding valuation levels, triggering deleveraging, and tightening credit conditions); second, the sharply increased tariff levels are difficult for any party to bear alone (exporters, importers, consumers).

Under the "price increase constraints" faced on both the supply and demand sides of the U.S. economy, U.S. tariff inflation may be overestimated.

First, on the demand side, consumer confidence expectations have fallen to a multi-year low.

Before the consumer confidence index showed a downward turning point, there was already a pre-consumption of durable goods in the U.S., indicating that the consumption data at that time already included some tariff expectations.

The advance stockpiling by households reflects their sensitivity to potential tariffs, which means consumers may not be willing to pay for high tariffs but will choose to directly reduce consumption.

Against the backdrop of weak consumer confidence and high auto loan rates, U.S. auto consumption in March recorded a new high in four years, reflecting consumers' avoidance of the impending auto tariffs; future demand will inevitably decline rapidly.

The current consumption slowdown includes not only the pre-consumption of goods and the decline in consumer confidence but also the natural decline in service consumption.

For example, the decline in non-essential consumption such as domestic travel in the U.S., the continuous decline in hotel occupancy rates with year-on-year contraction, and the sharp deterioration of same-store revenue indicators in the restaurant industry are all concrete manifestations of weakening service consumption.

All of this has occurred before the reciprocal tariffs, and it can be anticipated that under the shadow of tariffs, the natural weakening of these service consumptions will be amplified.

The "financial deflation effect" of tariffs on demand cannot be ignored.

This round of systemic tariff shocks is not merely a demand shock; it will also activate fragile financial tightening.

Especially when U.S. stock valuations are at historically relatively high levels, it triggers the classic Kindleberger-Minsky financial instability cycle (at least part of which has already occurred).

So far, the broad tariff shocks have a much more severe tightening impact on global risk appetite than the inflation impact of the tariffs themselves.

The current phased decline in U.S. stocks may just be the beginning. Further advancing large-scale tariffs in the context of already highlighted financial fragility will lead to "financial deflation" results: lowering profit expectations, eroding valuation levels, triggering a certain degree of financial deleveraging (selling off U.S. assets), and tightening credit conditions.

For enterprises, "financial deflation" means that the willingness of the financial sector to lend will shrink as corporate profitability declines, suppressing corporate capital expenditure willingness and buyback levels, triggering the beginning of a new cycle.

For residents, "financial deflation" refers to the reversal of the wealth effect from U.S. stocks and the decline in real purchasing power brought about by tariffs, suppressing residents' consumption willingness.

Secondly, on the supply side, companies are using a delay in price increase strategy to bet on the unsustainability of high tariffs.

From a "political" perspective, indiscriminate global reciprocal tariffs are a means rather than an end.

If one sees through the essence of tariffs, stakeholders may choose to adopt a "delay" strategy to bet on the unsustainability of U.S. tariffs, which is precisely the underlying thinking behind the slow progress of trade agreements between various countries and the U.S.

At the same time, traders will shift their attention from daily business needs to the process of rushing to renegotiate contracts, reconfigure supply chains, and lobby for tariff exemptions—all taking place in an uncertain and highly politicized trade environment.

The advance inventory buildup by U.S. companies in response to preemptive consumer spending has also increased their short-term ability to "share the tariffs." Slightly increased inventory combined with clearly weakening demand, along with higher overall profits and returns, limits the ability and willingness of companies to raise prices.

In the context of reinforced recession expectations, the best response strategy for U.S. companies is to make small, frequent price adjustments. The latest local Federal Reserve Beige Book (Philadelphia, Dallas, New York) also shows that the "direction" of price increases is clear, but the "magnitude" is not, with "small price increases" being more reasonable than "large price increases."

Finally, non-tariff factors such as DOGE, immigration policies, and increased crude oil production have also lowered U.S. inflation.

Aside from tariffs, the impact of non-tariff policies is still resonating, with tariffs acting as a catalyst for the U.S. recession rather than the cause.

The negative impact of DOGE reforms has already begun to show in corporate profits. For example, Verizon reported a loss of 289,000 paid phone customers in the first quarter, matching the worst quarterly performance on record, partly due to subscription losses from the federal government.

Since Trump took office, over 1,800 small business contractors have had their contracts terminated, far exceeding the average levels of previous years.

We are currently in the painful adjustment period of DOGE reforms: the decline in spending is only a drop in the bucket for balancing finances, but it represents significant revenue for any business.

Amid expectations of recession brought about by tariffs and non-tariff policies, commodity prices, led by crude oil, have rapidly declined. Saudi Arabia has clearly stated its ability to maintain a "low oil price" status in the long term, and the process of oil-producing countries massively releasing idle capacity to seize market share has just begun.

OPEC+ has been moderately increasing production since April, but with the worsening cheating behavior over the past month, Saudi Arabia will further increase production by 411,000 barrels in May, three times the expected amount; it is even considering accelerating production increases again in June.

From the perspective of tariffs, the forced front-loading of demand, the financial deflation effect, and the "dragging" of enterprises will suppress the upward level of inflation.

From the non-tariff perspective, the low-key advancement of DOGE reforms, the competitive production increases from OPEC+, and the ongoing recession impact will also suppress U.S. inflation levels.

There is a risk that tariff inflation is overestimated, but the Federal Reserve needs a "more reasonable" interest rate cut decision.

The Federal Reserve may still emphasize observing whether tariff inflation is a one-time effect (even if there are risks of underperformance), which means that at least two months of data need to be observed before taking action, allowing more time to avoid questions about "independence."

Such a trajectory of action faces the risk of falling further behind the curve, thus requiring a larger magnitude of interest rate cuts, such as 50 basis points, to respond to the slowdown in economic growth; otherwise, it will be unsatisfactory on both fronts: neither firmly combating inflation nor actively stabilizing growth.

Authors of this article: Song Xuetao, Zhong Tian, Source: Xuetao Macro Notes, Original Title: "Potentially Overestimated U.S. Tariff Inflation (Guojin Macro Zhong Tian)"

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