The market reaction is muted, but don't think that the end of tariffs means that stagflation is not the most concerning risk

Although the market has reacted mildly to the latest round of tariff threats, investors should not let their guard down. Bank of America and JP Morgan have both issued warnings that the risk of stagflation facing the United States is rising, which could be more threatening than short-term tariff fluctuations.

The U.S. government previously announced a new round of tariff measures. According to CCTV News, on July 12 local time, U.S. President Trump posted a letter to Mexico and the European Union on the social media platform "Truth Social," announcing that starting August 1, 2025, the U.S. will impose a 30% tariff on products imported from Mexico and the EU. According to previous information, Japan and South Korea face a 25% tariff rate, while Brazil faces punitive tariffs of up to 50%.

According to information from the Chase trading desk, Bank of America analysts stated in a report on July 11 that if these threats are fully implemented, the effective tariff rate in the U.S. will rise from the current 13.4% to 14.9%, and in a "no deal" scenario, it could reach levels of 18-20%.

Analysts warn that the new tariff language increases the risk of stagflation, characterized by higher inflation and lower economic activity, as uncertainty rises, and the supply shocks caused by increased tariffs and supply chain disruptions drive up inflation expectations.

In this context, due to concerns about the lagging effects of tariffs on inflation, the Federal Reserve is unlikely to marginally cut interest rates. Companies will steadily pass costs onto prices to avoid losing market share. This will extend the strategy of "escalate first, de-escalate later," which will only increase the likelihood of the Federal Reserve remaining cautious.

Uncertainty Will Persist in the Second Half of the Year

In response to Trump's new tariff measures, U.S. stocks and bonds have shown almost no reaction. The mainstream view is that tariffs will ultimately stabilize at reasonable levels, and some agreements will be reached, making this round of negotiations negligible as it will not cause significant damage.

Bank of America stated that as the U.S. stock market ignores the new shocks, the likelihood of consumer confidence being affected decreases. The Trump administration may be more motivated to escalate (tensions) again, as the marginal cost is very low.

The next question is, how much tension the market is willing to endure before the prices of risk assets decline, and how much pain Trump is willing to bear before easing tensions as he did in April. In other words, there are multiple equilibrium states in the game between Trump and the market.

Bank of America analysts expect that as attention gradually shifts to the midterm elections, uncertainty will persist in the second half of 2025 and stabilize by the end of the year. If the announced tariff measures are implemented, the U.S. is expected to face an effective tariff rate close to 14%, with further upside risks if comprehensive tariffs of 15%-20% are implemented

Stagflation Risk: Multiple Pressures Converge

According to Bank of America data, despite the implementation of tariffs for several months, the transmission to consumers is still ongoing. The tariff rate achieved in May was approximately 12.3%, which is basically in line with expectations, but the lag in transmission means that inflationary pressures will gradually emerge in the coming months.

Analysts expect the core CPI in June to rise by 0.29%, mainly supported by rising prices of goods driven by tariffs. In particular, the price trends of import-intensive goods such as electronics and household items have shown a significant shift, interrupting the previous downward trajectory.

Bank of America believes that the new tariff measures have increased the risk of stagflation, which is characterized by higher inflation and lower economic activity, due to increased uncertainty and the impact of supply shocks caused by higher tariffs and supply chain disruptions on inflation expectations.

JP Morgan stated that the market is currently severely underestimating the impact of tightened immigration policies on the U.S. labor market. The termination of the CHNV and TPS immigration programs will affect 1.8 million immigrants, of which about 1.1 million are employed, accounting for 0.8% of the total U.S. employment.

This impact will be concentrated in the second half of 2025, with an expected average monthly job loss of 117,000 in the third quarter and reaching 150,000 in the fourth quarter. More concerning is that the intensified ICE detention actions could bring an additional employment shock of 270,000 people. This sharp contraction in labor supply, with relatively stable demand, will drive up wages and service prices.

The Federal Reserve's Dilemma

Under stagflation pressures, the Federal Reserve faces a difficult choice.

Federal Reserve Chairman Jerome Powell has repeatedly stated that the Fed wants to have a clearer understanding of the impact of policy changes before taking the next step.

Bank of America believes that if there is still a risk of further significant adjustments to the tariff system, this clarity may not be achievable. Of course, if the labor market reverses, the Fed may be forced to act. However, given that the unemployment rate fell to 4.1% in June, and the initial jobless claims have returned to normal after a seemingly seasonal rise in June, there are no obvious signs of weakness in the labor market.

Bank of America emphasizes that the Fed's concerns about the delayed effects of tariffs make it inclined to remain patient. The price smoothing strategies adopted by companies to avoid losing market share mean that inflationary pressures will be more persistent.

JP Morgan expects that the actual GDP growth in the U.S. will slow to an annualized rate of 0.75% in the second half of the year, while the core CPI will accelerate to an annualized rate of 5%. This typical stagflation combination will severely constrain the Fed's policy space, making it difficult to support growth through interest rate cuts. In this environment, the traditional logic chain of "slowing growth = monetary easing = favorable for risk assets" will be broken. Investors need to prepare for an environment of declining growth but rising inflation and tightening liquidity. This stagflation risk is far more concerning than short-term tariff fluctuations