U.S. Inflation Still Robust Even Before Tariff Impact
The risks are skewed in one direction: up.
I recently had the chance to join Jack Farley of Monetary Matters podcast to talk about Trade Wars Are Class Wars and how it relates to current events.
Traders responded to the latest batch of U.S. inflation releases as if the news were benign, with yields on benchmark Treasurys falling.
One reason is that tariffs do not seem to have had much of an impact (yet). Despite the surge in customs receipts and the anecdotal news reporting, the prices paid by consumers for imported goods such as sporting equipment, apparel, and motor vehicles were all tame. Prices for “information technology commodities” and “major appliances” have been rising rapidly relative to their pre-tariff trends, but the overall Consumer Price Index (CPI) for durable goods nevertheless fell slightly from January to May on a seasonally-adjusted basis. (This is likely temporary and attributable to the massive stockpiles of imported inventories accumulated before any tariffs kicked in.)
At the same time, the pace of rent increases has now fully decelerated to the pre-pandemic pace. Other odd categories that had been disproportionate sources of price growth, such as motor vehicle insurance, also seem to have moderated. Put it together and the annualized headline CPI inflation rate so far in 2025 is just 2.3%, barely faster than the pre-pandemic average rate of 2.1% a year. That is much better than the 12-month CPI inflation rate for 2024 (2.9%) or 2023 (3.3%).
However, a closer look under the hood suggests that there is less to this improvement than meets the eye. As I noted last week using the Personal Consumption Expenditures (PCE) price index preferred by Federal Reserve officials, as well as the monthly data on hourly pay, underlying inflation seems stuck around 1-1.5pp faster at a yearly rate than before the pandemic. Moreover, the latest Producer Price Index (PPI) data on what businesses in America are charging customers for manufactured goods suggests that there is considerable upside risk to inflation coming from higher input costs, which would be consistent with most analysts’ expectations of the impact of tariffs.