CICC: The biggest risk to the U.S. economy remains "stagflation," and we need to be vigilant about the potential volatility that financial markets may face as a result

According to the Zhitong Finance APP, CICC has released a research report stating that the biggest risk to the U.S. economy remains "stagflation-like." Under the dual effects of tariffs and immigration policies, both demand and supply are suppressed in the short term, and structural inflation may form in the medium term. Declining consumer confidence, reduced corporate investment willingness, and divergences in bond market signals have all shown characteristics of "stagflation-like." On the policy front, the Federal Reserve's interest rate cuts may provide a temporary buffer, but it is difficult to change structural factors and may even reinforce inflation stickiness. Historical experience indicates that "stagflation" is not merely a cyclical phenomenon but a result of the interplay of policy, structure, and market expectations. In this context, it is necessary to be vigilant about the potential risk spillovers in the U.S. economy and the volatility that financial markets may face as a result.

CICC's main points are as follows:

1. The alternating effects of tariffs and immigration policies

In previous reports, it has been pointed out that the U.S. is entering an era of "high tariffs and high interest rates." The latest data shows that this policy combination is still ongoing. Since August, the U.S. has not reached any new tariff reduction agreements, but has instead raised the tariff rate on imports from India to 50% (Chart 1). Meanwhile, government tariff revenues continue to increase; according to Treasury Secretary Yellen's recent statement, tariff revenues alone are expected to exceed $300 billion this year, with potential further increases (Chart 2). The Congressional Budget Office (CBO) has recently estimated that tariffs could contribute approximately $4 trillion in revenue to the treasury in the future, significantly higher than the previously estimated $2.8 trillion.

Chart 1: The effective tariff rate in the U.S. remains as high as 20%

Source: USITC, Wind, CICC Research Department

Chart 2: Significant increase in tariff-related fiscal revenue

Source: Haver, CICC Research Department

The increase in government tariff revenue means that the private sector will bear higher costs. If tariffs are borne by businesses, corporate profits will be eroded, thereby suppressing hiring and investment demand; if borne by residents, prices will rise, living costs will increase, real purchasing power will decline, ultimately weakening consumer spending. In other words, tariffs have a contractionary effect on total demand (as tariffs are essentially a form of taxation), and their impact on inflation depends on the extent to which costs are passed on to consumers.

In addition to tariffs, the U.S. economy faces another policy challenge: tightening immigration policies. In recent years, the supply of labor and population growth in the U.S. has largely relied on immigration. From 2021 to 2024, the Biden administration's border policies have been relatively lenient, leading to an unprecedented surge in immigration in the U.S. The CBO estimates that the U.S. has seen a net increase of 7.3 million "other foreign citizens" (including undocumented immigrants and some who have obtained temporary asylum status), far exceeding the pre-pandemic average of about 100,000 per year Unlike previous waves of illegal immigration, many of the current influx have obtained temporary asylum status and work permits, effectively boosting labor supply. However, with the Trump administration tightening immigration policies, there has been a noticeable decline in immigration inflows (Chart 3). This is reflected not only in the decrease in inflows but also in the increase in outflows (the scale of deportations has risen).

Chart 3: Immigration inflows have shown a significant decline

Source: CBO, CICC Research Department

The slowdown in immigration will weaken labor force growth and put pressure on economic expansion. Data from the Department of Labor shows that the foreign-born labor force has declined this year, and the labor participation rate has also fallen, indicating a contraction in labor supply (Chart 4). The decline in the immigrant population will also weaken demand; one channel is that the momentum for consumption growth will diminish, and another channel is that the decrease in housing demand will exacerbate the already pressured real estate market. A study by the Dallas Federal Reserve pointed out that tightened immigration policies could reduce the growth rate of U.S. real GDP by 0.81 percentage points and increase the PCE inflation rate by 0.15 percentage points by 2025.

Chart 4: The foreign-born labor force has shown a significant decline

Source: Haver, CICC Research Department

Another factor worth noting is the potential spillover effects of China's "anti-involution" policies. In recent years, the slowdown in U.S. inflation has also been related to the slow growth of China's PPI and export prices, but if China's PPI rebounds, combined with tariffs, it may also exert upward pressure on U.S. inflation.

Overall, tariffs and immigration policies are both supply shocks that have a "stagflation" effect: in the short term, the "stagnation" impact may be more significant, as tariffs suppress consumption and investment demand, while tightened immigration restrains job growth; in the medium term, the "inflation" stickiness will gradually become apparent, as companies pass on tariff costs to consumers, and the decline in labor supply will push up structural inflation. Therefore, the biggest risk the U.S. faces in the coming year remains "stagflation-like."

2. Survey data indicates "stagflation-like" conditions

Recent economic and financial market data have shown characteristics of "stagflation-like" conditions: first, consumer confidence and inflation expectations are diverging. The August University of Michigan Consumer Confidence Report shows that consumers' inflation expectations for the coming year have risen, but overall confidence has declined (Chart 5). The August Conference Board Confidence Index also exhibited a similar trend (Chart 6). This combination indicates that residents are pessimistic about the economic outlook while also worrying that prices are unlikely to decline in the future.

Chart 5: Consumer inflation expectations rise, but overall confidence declines

Source: Wind, Haver, CICC Research Department

Chart 6: The Conference Board Consumer Survey also shows a similar trend

Source: CEIC, CICC Research Department

Secondly, there is a divergence in manufacturing costs and investment willingness. In August, the manufacturing PMI price index tracked by the five major regional Federal Reserve banks generally rose, indicating increased cost pressure from raw materials faced by enterprises. On the other hand, while corporate capital expenditure willingness has shown some signs of recovery, it remains at a low level (Chart 7). In comparison to 2021-2022, when the manufacturing price index rose alongside strong investment willingness, indicating an overheating economy; the current situation is characterized by rising costs and sluggish investment willingness, which aligns more with the characteristics of "stagflation."

Chart 7: Manufacturing Survey: Rising Payment Prices, Declining Investment Willingness

Source: Wind, Haver, CICC Research Department

Thirdly, signals from the bond market. Analyzing the 10-year U.S. Treasury bonds reveals that since July, implied inflation expectations (Breakeven) have risen, while real interest rates have declined (Chart 8). This indicates that investors are demanding higher inflation compensation while expecting future real returns to decrease.

Chart 8: Rising Implied Inflation Expectations for U.S. Treasuries, Declining Real Interest Rates

Source: Wind, CICC Research Department

The latest Beige Book also points out rising cost-side price pressures amid economic slowdown: the overall U.S. economy is basically flat, with only a few regions experiencing moderate growth, but price pressures are heating up, and consumer spending is generally weakening due to tariffs and economic uncertainty affecting real income. The Boston Fed report indicates that a clothing retailer in its district has raised prices on about half of its products by 10% to 15%, while other retailers have raised prices to a lesser extent but also report that manufacturers are bearing a higher proportion of tariffs than expected. The New York Fed report states that several companies in its district plan to raise prices to offset increased costs due to tariffs on imported goods, with one European steel company claiming to have passed all tariff costs onto customers. An increasing number of respondents expect the pace of price increases to accelerate in the coming months; Corresponding to the price pressures, economic activity in the region has slightly declined, as ongoing tariff uncertainties continue to put pressure on businesses. According to the Philadelphia Fed report, the trimmed mean of inflation expectations among all businesses in the region rose from 3.0% in the same period last year to 4.7%; at the same time, respondents indicated that many households' income growth is not keeping pace with rising prices. The surveyed businesses reported that since last quarter, more than half of their customers have become more sensitive to price changes.

3. The Fed's interest rate cuts may not be smooth sailing

Against the backdrop of increasing short-term employment pressures, the Federal Reserve may be inclined to cut interest rates first. Powell's speech at the Jackson Hole meeting outlined the Fed's policy "reaction function," emphasizing the necessity of addressing the risks of employment downturns. However, as inflationary stickiness gradually becomes apparent, the balance of risks may shift, and the Fed's policy focus may have to return to inflation control. This means that the extent of the Fed's interest rate cuts may not be large, and the process may be more tortuous than the market expects.

Historical experience shows that the formation of "stagflation" is often not merely a cyclical phenomenon but rather the result of the interplay of policy, structure, and market expectations. The "Great Stagflation" of the 1970s appeared to be caused by oil price hikes due to oil embargoes imposed by Middle Eastern countries, but there were deeper underlying factors, including: excessively loose monetary policy, uncontrolled consumer inflation expectations; rapid population growth, expansion of social welfare policies, and strong rigid demand from residents; strong union power leading to rigid wage increases; price control measures taken by the Nixon administration reducing efficiency; and the collapse of the Bretton Woods system leading to the depreciation of the dollar.

Today, the United States similarly faces policy and structural challenges: relatively loose fiscal policy with high deficits; the Trump administration's attempts to intervene in monetary policy; significant tariff increases with a trend towards normalization and institutionalization; global supply chain restructuring leading to reduced production efficiency; worsening population aging and declining labor participation rates; tightening immigration policies that may persist long-term; and market expectations of dollar depreciation. These factors may constrain supply, making supply shocks occur more frequently. Therefore, while the likelihood of the U.S. experiencing another "Great Stagflation" is low, the risks of "quasi-stagflation" should not be overlooked. It is necessary to be vigilant about the potential spillover risks to the U.S. economy and the volatility that financial markets may face as a result