- Demand is slowing, as per a range of indictors of activity.
- Inflation risks are entirely policy inflicted.
- Retailers last faced price pressure like this was back in mid-‘22, when inflation was 9%.
- Inflation momentum is on the rise, price pass-through to consumers is coming.
- The Fed’s policy balancing of weak growth against rising inflation would make or break markets.
Commentary: Upside risks to US inflation
So far, so good. Despite fears of a sudden jump in prices after the April reciprocal tariff bombshell, US inflation remained in the 2.5-3% range in 2Q, according to a variety of measures. Energy prices are well behaved, and the same stands for food, metals, electronics, autos, and a range of durable goods.
We think however that this is as good it gets. Granted, the risk is not from the demand side. Along many indicators of activity, the US economy is showing signs of weakness, ranging from retail sales to home completions, private sector hires to PMI readings from manufacturers. All such indicators point to an economy at risk of stalling or contracting.
The issue is entirely policy inflicted. Tariff mayhem caused a massive spike in imports, which is fading. Retailers, having squeezed their suppliers first and taking a hit on their balance sheet next, have no other course of action left to deal with tariffs that are at their highest in the post-WWII history. They are bound to raise prices in the coming months, we are sure.
The telltale signs are widespread. Regional manufacturers are reporting the highest price pressure since the summer of 2022, when inflation was hovering around 9%. Whether measured by Dallas Fed’s trimmed mean inflation on an annualised basis or indicated by the lead-lag relationship with money supply, forward looking indicators are pointing toward rising inflation ahead.
As inflation heads past 3%, a series of complications would occur. The US authorities have repeatedly expressed a desire to see lower short-term interest rates, along with some revealed preference to be amenable to a weaker USD. Add to this large tax cuts from Big Beautiful Bill that will likely inject additional stimulus to the economy, the Fed is about to find itself in a daunting situation. Pressure from the president, including via his forthcoming Fed appointments, would mount. Demand side weakness will provide additional motivation. But how will the Fed ignore 3%+ inflation? On account of the occurrence being “transitory?” Well, we have been there before.
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