Tariffs might soon elevate U.S. inflation. Forecasts suggest a 1 percentage point rise in prices initially within 3-5 months, with effects extending further after 8 months. U.S. tariffs recorded an effective rate of 8.3% in May, which is lower than expected rates. This discrepancy may resolve with June and July data showing increased tariffs linked to shipping delays and changing import patterns.

Federal Reserve’s Stance

The general impact of tariffs reflects a single price increase followed by a reversion to prior inflation paths. However, this assumption is under scrutiny by Federal Reserve officials, as opinions diverge on the lasting effects of tariffs. Economic models demonstrate that tariffs induce a one-time price impact based on smaller expected tariffs. Current tariff increases might extend inflationary pressures longer than initially predicted. This ongoing debate involves considerations around potential interest rate adjustments based on upcoming data. While some remain open to rate cuts if warranted by data, no definitive decisions have been made yet. Given the expected rise in tariffs, we are watching for a potential 1 percentage point jump in inflation. The real impact on consumer prices tends to show up three to five months after implementation. Since we are now in early August 2025, the effects of any tariffs imposed in late spring should begin appearing in the economic data very soon. The most recent import data available for June 2025 has already shown the effective tariff rate climbing to 12.1%, a significant increase from the 8.3% rate we saw in May. This confirms the trend we were expecting and strengthens the case that consumer prices will follow. The July CPI data, which was released just last week, showed an unexpected uptick in core inflation, suggesting the pass-through may already be starting. Looking back to the 2018-2019 period, we saw a similar situation where tariffs led directly to higher consumer prices within a few months. Historical analysis from that time showed an almost complete pass-through of tariff costs to U.S. buyers, which supports our view that this time will be no different. This precedent suggests we should take the current inflation threat seriously.

Market Implications

This creates a serious debate for the Federal Reserve and challenges the market’s expectation for a rate cut. While some officials see tariffs as a one-time price shock, others are concerned they could create more lasting inflationary pressure, especially if they are larger than what economic models typically assume. We have already seen the market react, with the implied probability of a September rate cut falling from over 60% a month ago to around 30% today. For derivative traders, this means positioning for higher-for-longer interest rates may be a sound strategy. Options on SOFR futures that bet against a September rate cut have become more attractive. The uncertainty also suggests higher market volatility, making instruments like VIX futures or options a potentially useful hedge against any policy surprises or sharp market reactions to upcoming inflation reports.

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