Goldman Sachs: Why the impact of tariffs on U.S. inflation is transitory?

According to the Zhitong Finance APP, Goldman Sachs expects that tariffs will have a one-time upward effect on domestic price levels in the United States, causing the core Personal Consumption Expenditures (PCE) inflation rate to rebound to 3.6% later this year, before falling back next year. However, the memory of soaring inflation during the pandemic, along with the situation where inflation expectations from the University of Michigan have exceeded the pandemic peak, has led some to worry that this year's inflation rebound may be more persistent.

The main reason Goldman Sachs is less concerned is that it expects the U.S. economy to perform weakly this year, with growth far below potential levels and a slight increase in the unemployment rate.

Additionally, Goldman Sachs believes that the upcoming inflation rebound poses less of a threat than during the 2021-2022 period, as the cumulative inflation overshoot is much smaller, the tightness of the labor market is significantly lower, forward-looking wage indicators have continued to decline, and household consumption capacity is no longer elevated due to fiscal transfers. Even during earlier extreme periods, high inflation ultimately did not become as psychologically entrenched as many feared at the time, and inflation and inflation expectations gradually normalized without the need for a recession.

Aside from tariffs, recent other inflation-related news has actually appeared somewhat weak. Therefore, Goldman Sachs believes that once the impact of tariffs fades and inflation slows, the Federal Open Market Committee (FOMC) is still expected to eventually implement some final normalization rate cuts. If, contrary to Goldman Sachs' expectations, tariffs against specific countries rise to prohibitive levels, leading to shortages or tariff escalations continuing until 2026, Goldman Sachs would be more concerned about the prolonged inflation caused by tariffs.

Why Goldman Sachs expects tariffs to only have a one-time impact on inflation

As tariff rates significantly exceed the expectations on inauguration day, and some inflation expectation survey indicators have surpassed pandemic peaks, whether tariffs will trigger a sustained surge in inflation has become a more intriguing question than initially thought.

Goldman Sachs predicts that tariffs will cause consumer prices to rise by about 2% over the next year and a half, surpassing the deflationary forces that have been at play over the past few years. Therefore, Goldman Sachs expects the year-on-year core PCE inflation rate to accelerate by about 1 percentage point, peaking at 3.6% in December, but as the one-time push from tariffs disappears from year-on-year calculations, the inflation rate will fall back in 2026. But will this year's rebound be more persistent?

The same question dominated macroeconomic debates at the end of 2021 and in 2022. At that time, short-term inflation expectations rose sharply, and businesses sometimes seemed overly adapted to a high-inflation environment, even though long-term expectation indicators remained stable. The end of supply shocks and the resolution of shortages took longer than expected, but once they ended, it proved that high inflation did not become as psychologically entrenched as many feared, and inflation and inflation expectations gradually normalized without the need for a recession.

Some commentators believe that two aspects of the current situation are more concerning.

First, price and wage-setting standards may be less firmly anchored to the 2% target, as the U.S. has just experienced a round of inflation surge.

Second, inflation expectations from the University of Michigan have risen more than in 2022, and this time long-term expectations have also risen significantly, even though tariffs have not yet significantly pushed up consumer prices These are all reasonable concerns, although the technical details exaggerate the increase in the University of Michigan survey, while other survey indicators and market-implied inflation compensation have not risen significantly after the next year (Figure 1).

From the figure, it can be seen that the University of Michigan's inflation expectations have exceeded the peak during the inflation surge of the pandemic, although other surveys and market indicators have not risen significantly after the next year.

(Figure content: The left chart shows survey data on 1-year inflation expectations from different institutions for consumers from 2017 to 2025; the right chart shows the 10-year inflation swaps in the bond market and consumer 3-year and 5-year inflation expectations during the same period. Note: Adjustments for partisan leanings and sample design; there is a 0.25 percentage point gap between CPI and PCE indices; May figures are as of the close on May 16.)

Despite these concerns, Goldman Sachs believes the current situation is less worrisome than the panic of 2022. The main reason is that Goldman Sachs expects the economy to be weak this year, with GDP growth of only 1%, which is half of Goldman Sachs' estimate of the potential growth rate, and the unemployment rate is expected to rise slightly to 4.5%. Goldman Sachs is skeptical about the prospect of long-term high inflation in the case of mediocre economic performance.

There are three key differences compared to the environment in 2022 that make Goldman Sachs less worried today:

First and foremost, the upcoming inflation rebound may be far less extreme than the previous surge (Figure 2). This is reassuring because high inflation becoming psychologically entrenched and normalized in price and wage setting should be proportional to the height, breadth, and duration of the inflation outbreak experienced by consumers, workers, and businesses.

Figure 2: Goldman Sachs expects the upcoming inflation rebound to be far less extreme than in 2022, meaning it poses a much smaller risk of becoming psychologically entrenched in price and wage setting.

(Figure content: The left chart shows the actual overall PCE price index and year-on-year changes predicted by Goldman Sachs from 2019 to 2026; the right chart shows changes in the core PCE inflation rate during the same period.)

Secondly, the labor market in 2022 was in the tightest state in U.S. history, providing ready fuel for the wage-price feedback loop, whereas the labor market is now in a more normal balanced state (Figure 3 left chart). Accelerating wage growth will be a key intermediate step for sustained high inflation, but so far, with the unfolding trade war, concerns about the outlook seem to outweigh the boost from higher inflation expectations Goldman Sachs' wage survey leading indicator (which combines corporate and household expectations for future wage growth) has further declined to 2.9%, a level that may be consistent with inflation below target (Chart 3, right).

Chart 3: The labor market was historically tight in 2022, but is now in a more normal balanced state, with wage pressures further easing so far since the start of the trade war.

(Chart content: The left chart shows the job-worker gap from 1951-2023; the right chart shows the year-on-year changes in Goldman Sachs' wage tracking indicator and monthly wage survey tracking indicator from 2000-2024.)

Third, a few years ago, due to pandemic fiscal transfers, disposable income for consumers was higher than usual, but due to pandemic restrictions, the things available for consumption were fewer than usual. This unusual environment may have also fueled the spread of inflation—many companies heard that others were raising prices more than usual and attempted to raise prices more significantly themselves, only to be surprised to find that the impact on their sales was less than expected. In contrast, companies today have little reason to expect consumers to react so mildly, and may be more cautious about raising prices beyond cost increases.

Aside from tariffs, recent inflation news has actually been somewhat weak. In particular, Goldman Sachs' latest monthly inflation monitoring shows that the underlying inflation trend indicator remains flat, with new tenant rents rising only 1.4% over the past year (Chart 4), indicating that the largest and most cyclical categories have further slowed to a pace that may also be consistent with inflation below target.

Chart 4: Inflation news is weak aside from tariffs—especially, the alternative data leading indicator for new tenant rents has risen only 1.4% over the past year.

(Chart content: Shows the year-on-year changes and average levels of alternative rent indicators from institutions like Zillow, Yardi, and CoStar from 2019-2025, with specific values not fully presented due to format limitations.)

Therefore, Goldman Sachs believes that once the impact of tariffs fades and inflation slows, the FOMC is still expected to implement some final normalization rate cuts. Goldman Sachs expects the maximum impact of tariffs to appear in the inflation reports from May to August, and has tentatively scheduled the first rate cut for December, although it is difficult to determine how much evidence Federal Reserve officials want to see indicating that tariff pressures have dissipated before resuming rate cuts What could make tariff-driven inflation rebound more dangerous?

The simplest lesson from the experience of 2021-2022 is that more extreme and persistent supply shocks than initially expected led to shortages and ultimately resulted in more extreme and persistent inflation. The United States and China recently suspended the most extreme tariffs that could lead to production disruptions, supply chain issues, and shortages. However, if tariffs against specific countries rise to prohibitive rates contrary to Goldman Sachs' expectations, or if tariff escalations continue until 2026, Goldman Sachs would be more concerned about high inflation lasting longer. (Meirikel)