However, there is uncertainty around the relative size of these impacts.
Amid this uncertainty, we believe the Fed will proceed cautiously with additional easing while needing to clarify its reaction function soon.
Profound uncertainty about the eventual tariff mix
Following the imposition of 25% tariffs on imports from Mexico and Canada (with a lower 10% rate on energy from Canada), and an additional 10% tariff on China, we estimate that the US average weighted tariff rate has risen from 3.3% at the start of President Trump’s term to about 12% based on current trading patterns. This is a level last reached in the 1930s.
However, there is substantial uncertainty about the outlook for these latest tariffs and the broader US tariff mix.
In a speech to Congress on March 4, Trump seemingly brushed off economic and market concerns about tariffs, saying there may be “a little bit of an adjustment period.”
On the other hand, some members of the administration sound more uncomfortable with the rapid rate of tariff increases on large trading partners. For example, Commerce Secretary Howard Lutnick has suggested that the Canada and Mexico tariffs may be reduced in exchange for concessions.
Stepping aside from the latest spat, more tariffs are almost certainly coming, including reciprocal tariffs and additional product-specific tariffs on sectors such as steel and aluminum, autos, pharmaceuticals, and semiconductors. Indeed, putting together the full mix of Trump’s latest tariff threats, we estimate that they could still push the US average weighted tariff rate substantially higher (Chart 1).
Chart 1. Adding together all of Trump’s tariff threats would take the US average weighted tariff rate well above 1930s' peaks
A “Trumpcession” to come?
Expectations for Fed rate cuts have been building as market worries about a “Trumpcession.” At the same time, US GDP growth nowcasts have worsened dramatically. The Atlanta Fed GDPNow model is tracking a 2.8% annualized contraction in GDP in Q1.
This likely overstates the decline in activity early this year, given challenges accounting for the swings in trade and inventories. Even so, it has been a soft start to 2025 across a range of survey data and some hard activity indicators.
This weakness partly reflects problems with seasonal adjustment at the start of the year. Severe weather has also likely temporarily weighed on growth. Meanwhile, the weakening in the survey data follows a large surge after Trump’s election win, and the soft data has been a less good guide to activity over recent years.
Nevertheless, all this has led to the market reassessing the prospects of Fed easing this year. Around three full 25 bps rate cuts are now priced into fed funds futures markets, compared to one less than four weeks ago (Chart 2).
Chart 2. Markets pricing in more Fed support
A growth or an inflation shock?
We are currently in the process of refreshing our US (and indeed global) economic forecasts for the evolving trade and broader economic and geopolitical environment.
The last time we felt this uncertain about the policy conditioning assumptions that we should be using to underpin our forecasts was in the early days of the pandemic, as lockdowns were being rapidly imposed but it still wasn’t clear how widespread or long-lasting they would be.
Beyond what happens to tariff rates themselves, is how the economic impact of tariffs plays out between US growth and inflation and, therefore, how it impacts Fed policy setting.
However, a key uncertainty at play, beyond what happens to tariff rates themselves, is how the economic impact of tariffs plays out between US growth and inflation and, therefore, how it impacts Fed policy setting.
A very simplistic mechanical model would be that, by raising the price of imported goods into the US, this increases US inflation. Over the past 12 months, the US imported nearly $1.4 trillion of goods from Canada, Mexico, and China, equivalent to 4.8% of GDP. This trade covers a diverse range of sectors with transport equipment (autos), electronics, fuel, and machinery standing out as the largest.
The increase in tariffs on this trade delivered so far averages 19%, implying a “tax” of close to $260 billion based on current trading patterns. If passed entirely through to importers, this would equate to an increase in the US GDP deflator (i.e., the price level) of 0.9%.
However, in practice, modeling the impact of tariffs is (much) more complicated, as behavioral changes and currency adjustments can all affect where the incidence of this tax lands and, hence, the impact on the price level and economic activity.
For example, higher tariffs could push importers to move their supply chains to unaffected trade partners (as in the first US-China trade war) or domestic suppliers. In contrast, higher prices and supply-chain disruptions could reduce activity in the sector. The extent of this substitution effect will depend on the structure of the affected market, which differs significantly across product groups.
If the dollar appreciated higher tariffs, this could make the price increase of imported goods from the perspective of US consumers smaller but lower the competitiveness of US exports.
Additionally, currency changes can cushion the shift in relative prices but at the cost of lower economic activity. For example, if the dollar appreciated higher tariffs (again, as occurred in the first US-China trade war), this could make the price increase of imported goods from the perspective of US consumers smaller but lower the competitiveness of US exports.
We also need to consider how importers pass higher tariffs to the final consumer or absorb them into margins. Finally, how any additional tariff revenues are used – as fiscal stimulus or to reduce the deficit – will also have an impact.
Final thoughts
Overall, it seems most likely the Fed will be in wait-and-see mode in the short term, and we have been forecasting a single cut this year in September. Certainly, this inaction could be shaken by the apparent very rapid slowdown in growth, especially if the Fed sees this as more than statistical quirks and a risk to the business cycle expansion. It is also possible that a very sharp sell-off in equities and tightening in financial conditions could add to the need to cut rates more rapidly. But there are also risks that the Fed does not loosen at all, especially if the inflation impact of tariffs is large and front loaded. However, Chair Powell has put a high bar for the central bank hiking rates again, and this is likely to remain if growth slows while inflation remains hot. Either way, the Fed needs to clarify its reaction function to tariffs and other aspects of the Trump policy agenda further, to help manage market expectations.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
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