Trump's tariff suspension leads to market caution, inflation concerns remain

Despite concerns that the tariffs announced by Trump on "Liberation Day" may drive up inflation in the U.S., investors do not seem to be strongly worried about future price surges based on various market indicators.

According to the Zhitong Finance APP, Deutsche Bank macro strategist Henry Allen pointed out in a research report on Tuesday: "Although several inflation indicators are on the rise, U.S. inflation swap prices have changed little since 'Liberation Day'." He added, "Even with the announcement of large-scale tariffs, the relevant markets have remained almost indifferent."

Data shows that on April 2, after the U.S. stock market closed, Trump announced large-scale tariffs, and the one-year U.S. inflation swap on that day was 3.4%, compared to 3.36% last week. Inflation swaps are market-based indicators of inflation expectations, differing from the subjective expectations reflected in consumer surveys.

Although U.S. inflation has significantly eased from its peak in 2022, it remains above the Federal Reserve's 2% target and may temporarily rise again due to tariffs. Investors will face key data this Friday, the April U.S. Personal Consumption Expenditures Price Index (PCE), which is the inflation indicator most closely watched by the Federal Reserve.

Despite the initial market turmoil caused by the new tariffs, investors are also assessing subsequent changes in trade policy, including a 90-day grace period for "reciprocal tariffs," a 90-day reduction of certain tariffs on China, and Trump's recent announcement to delay the imposition of a 50% tariff on the EU. These changes are seen by the market as positive signals that may improve global trade relations.

Allen noted: "Perhaps investors expect the impact of tariffs on inflation to be minimal, but the volatility of other assets has clearly increased, indicating that the market still anticipates certain changes in the economy as a result."

Since April 2, if we extend the timeline, the overall volatility of inflation swaps remains low. The five-year inflation swap has slightly risen from 2.54% to 2.56%.

After Trump announced a new round of tariffs on April 2, the stock and bond markets initially reacted strongly, but as the White House advanced global trade negotiations, market volatility gradually calmed. The Cboe Volatility Index (VIX), which measures panic in the U.S. stock market, surged in early April but has now fallen back to around 20, close to the long-term average. The volatility indicator in the bond market, the ICE Bank of America Merrill Lynch MOVE Index, although still relatively high, has also significantly decreased since early April.

"Several forward-looking inflation indicators are concerning, showing an upward trend after 'Liberation Day'," Allen pointed out. He specifically mentioned that the preliminary value of the S&P Global Purchasing Managers' Index (PMI) released last week indicated that U.S. input costs and output prices both recorded the fastest growth since 2022 in May, "which seems somewhat inconsistent with the market's calm response to inflation expectations."The consumer price index (CPI) released earlier this month showed that the annual inflation rate in the United States was 2.3% for the 12 months ending in April. The core inflation rate, excluding food and energy, was even higher at 2.8%.

David Mericle, Chief U.S. Economist at Goldman Sachs, stated in a report on Monday: "We expect tariffs to drive prices up temporarily, causing the core PCE inflation rate to rebound to 3.6% later this year, before falling back next year." The core PCE he referred to is the inflation measure that the Federal Reserve focuses on.

However, Mericle also warned that the memory of soaring inflation during the COVID-19 pandemic has not faded, and the latest survey from the University of Michigan shows that U.S. consumers' inflation expectations have exceeded the pandemic peak, intensifying market concerns about persistent inflation.

According to the mid-May survey from the University of Michigan, U.S. consumers' expectations for inflation over the next year jumped from 6.5% in April to 7.3%.

Mericle added: "We are not overly concerned because we expect the U.S. economy to remain weak this year, with actual growth below potential levels and a moderate rise in the unemployment rate."

Meanwhile, there is a glimmer of hope in U.S. economic data. The Conference Board announced on Tuesday that the consumer confidence index for May rebounded after declining for five consecutive months, partly due to the "ceasefire" agreement reached in trade negotiations between the U.S. and China earlier this month.

Boosted by Trump's announcement to delay high tariffs on the European Union, investor sentiment improved significantly, leading to a sharp rise in the U.S. stock market on Tuesday. The Dow Jones Industrial Average rose by 1.8%, the S&P 500 index increased by 2%, and the Nasdaq Composite surged by 2.5%. In the bond market, the yield on the U.S. 10-year Treasury note fell by 7.6 basis points on Tuesday to 4.432%, marking the largest single-day decline since April 24