March 5, 2025

QuickTakes

Are Tariffs Inflationary Or Deflationary?

Are They Really ‘A Beautiful Thing?’

Until recently, the message from the bond market has been that tariffs are deflationary because they depress global economic activity. As Warren Buffett recently observed, they are a tax that consumers, importers, and/or exporters pay. It is widely presumed that tariff increases have a transitory, one-shot, price-rising impact.

Indeed, on Sunday, US Treasury Secretary Scott Bessent predicted that the Chinese "will eat any tariffs that go on." On Tuesday, the Trump 2.0 tariff on China was raised from 10% to 20%. It's unlikely that Canadians and Mexicans will eat the 25% tariff imposed under Trump 2.0 on Tuesday; rather, US consumers will. Recognizing this, on Wednesday the White House announced a one-month tariff exemption for automakers.

We've been forecasting that the 10-year US Treasury bond yield should range between 4.25% and 4.75% this year (chart). It fell slightly below that range in recent days during the tariff turmoil. Now it is back at 4.28%. The comparable TIPS yield has fallen recently on weaker-than-expected US economic data.

The expected inflation premium in the 10-year US Treasury TIPS market is highly correlated with the oil price (chart). Arguably, the recent weakness in the price of a barrel of crude oil reflects concerns that Trump's tariff war will weaken global economic activity. The price of oil was down $1.72 a barrel today to $69.31.

We aren't convinced that the US economy is weak. Today's ISM national nonmanufacturing PMI for February supports our position (chart). Today's ADP private payroll gain of only 77,000 during February did not. We are still expecting a solid employment report on Friday from the Bureau of Labor Statistics.

Meanwhile, February's prices-paid indexes in both the NM-PMI and M-PMI reports suggest that concerns about tariff-related cost increases are already showing up in both (chart).

This all adds up to a continuation of the choppy stock market for a while longer. That's especially true because anytime that the stock market takes a dive on Trump 2.0 tariffs, as it did on Monday and Tuesday, the activity will probably induce the administration to respond in a way that pushes stock prices back up, as we saw today. The stock market vigilantes should remind the President that tariffs may not be the "beautiful thing" that he believes.

Then again, Trump 2.0's America First approach seems to be forcing China to do more to stimulate domestic consumption and Germany to spend more on defense and on other fiscal outlays. Arguably, those are beautiful things. The measures announced by both countries to stimulate their economies today boosted their share prices and may continue to do so.

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