Why Tariffs Haven’t Shaken Markets Yet

Economists Say Inflation Impact May Be Brief, but Tariffs Could Alter Fed’s Rate Path

The return of “Tariff Man” is shaking up global markets, with President-elect Donald Trump reigniting trade tensions by pledging significant tariffs. On Monday, Trump announced plans to impose a 25% tariff on imports from Mexico and Canada and an additional 10% on goods from China, a move reminiscent of his first-term trade policies.

While the announcement triggered sharp declines in the Mexican peso and Canadian dollar, broader U.S. markets appeared unfazed. Ian Lyngen, a rates strategist at BMO Capital Markets, observed that investors were largely prepared for such measures, given Trump’s campaign rhetoric. “The market reaction reflects that tariffs have a one-time inflationary impact and were already priced in,” Lyngen said.

Markets Responses

U.S. Treasury yields saw some movement, with the 10-year yield briefly climbing to 4.311% following Trump’s announcement before stabilizing. Stock markets were more subdued, with the S&P 500 and Nasdaq Composite posting gains, while the Dow Jones Industrial Average dipped slightly after reaching a record high the previous day.

Economists warn that tariffs could temporarily raise inflation by making imports costlier, shifting demand to domestic goods or untaxed foreign imports. According to Oxford Economics, past U.S.-China trade tensions showed that every 1% increase in tariffs reduced Chinese imports by 2.5%. However, the broader inflationary effects were limited as retailers absorbed costs, and demand shifted to other suppliers.

Implications for Federal Reserve Policy

The potential inflationary impact of tariffs may influence the Federal Reserve’s stance on interest rates. After recent rate cuts aimed at supporting economic growth, further inflationary pressures could force the Fed to pause its easing.

Economists Carl Weinberg and Rubeela Farooqi of High Frequency Economics suggested that the Fed might adopt a wait-and-see approach, holding rates steady to assess the long-term effects of the tariffs. “If tariffs drive prices higher, the Fed is likely to delay further cuts, which could reduce GDP growth,” they noted.

Despite the muted market response, tariffs risk undermining economic demand and slowing growth in the U.S., a concern if the Fed decides to keep rates elevated.

Uncertain Tariff Outlook

The proposed tariffs’ longevity remains unclear. Trump tied their implementation to halting illegal immigration and drug trafficking, leaving the door open for negotiations with affected nations. Analysts suggest this approach mirrors Trump’s 2019 tariff threats, which were later withdrawn after Mexico agreed to policy changes.

Stephen Brown, deputy chief North America economist at Capital Economics, pointed out that uncertainty about the tariffs’ permanence likely tempered market reactions. “The implication is that countries could avoid the tariffs by presenting credible plans to address Trump’s concerns, just as Mexico did in 2019,” Brown said.

While the markets remain calm for now, investors are closely watching for further developments as they weigh the immediate inflationary impact of tariffs against their potential to reshape the economic and policy landscape.