New Tariffs, Old Fears: How Trump's Trade Plans Could Stoke Inflation

Stocks pulled back yesterday as exhausted investors looked more closely at THE NUMBERS that carried them there. Bond yields resumed their climb as bets for December rate cut weakened and longer-maturity yields gained in response to fresh inflation jitters.

Lights, camera … ACTION. It is July 25^th, 2018, and I am, as always, writing my daily market note. What motivated me on that morning was a Tweet (it was still Twitter back then) from Former, Future President Trump that simply read: "Tariffs are the Greatest." Tariffs had, at that point, become part of the market worry cycle which started in March, earlier in the year. By July we all knew by heart that tariff was spelled with an 'r' and two 'f's. I decided that I had had enough, I was going to explain the best way I knew to explain the possible negative impact tariffs can have. I started the following drawing taken directly from my notebook. Check it out - low tech.

Now, that was many notebooks ago, but it is still quite relative today as Donald Trump prepares to take back the keys to the White House, and with him a Republican Senate with a possibly Republican House. He has tariffs on his mind this time around again, and that has stirred up some serious nerves once again. But, in famous Wall Street terminology, "this time, it's different."

This time, it is a little different. When I wrote that original note, Consumer Price Index / CPI was at 1.6%, far lower than the CPI print of 2.6% we are expecting later this morning. Moreover, we would be remiss if we didn't mention that inflation was at 9.1% less than 2 years ago. Let us also not forget that Trump voters were not happy with the inflation credited to President Biden. This time, tariffs and inflation are two things which have not just the ability to take the wind out of the sails of the bulls but also cause real bona fide inflation. Let's dig in a little more.

When we think of inflation, we typically think about the "things" we buy. The technical term for that is "Goods." Televisions, cars, dishwashers, furniture, clothes, etc. But in this last spate of inflation, we learned to think of "Services" and "Food." Services inflation is still quite sticky, as we know. Food inflation has come down (that is disinflated), but it is still a point of discomfort for many folks - er, voters. Finally, back to Goods inflation. Goods have actually deflated, or, come down in price. That deflation has helped bring down the topline inflation figure. Have a look at the following chart of Core Goods CPI.

You will note that earlier in 2024, Goods inflation was as high as 2.5% in 2022, but for the most part stayed around the 0% line for the better part of the past decade, notwithstanding the post pandemic inflation surge. Now let's take a look at Food CPI in the following chart.

On this chart, we note that Food inflation was in a positive trend (that means increasing inflation) from 2016 onwards. It spiked during the pandemic (which was due to low supply) and again in late 2022. As aforementioned, it did disinflate, but it remains high compared to the pre-pandemic period. You will note that last month's read of Food CPI was 2.27%, still higher than the Fed's 2% target.

Ok, so why did I just show you these two charts? Because it is these two areas which would be most impacted by tariffs. Avoid my drawing from above, I will happily direct you to a link of my old post if you want to geek out on it. For now, let us assume firms are rational. That is to say, that they will do everything in their power to maximize their returns. A rational firm, therefore, if faced with increasing costs, will pass along those increases to consumers - you and me. That is a fact, folks, no drawings necessary. Do you agree? If you do keep reading.

Trump has proposed a 10% tariff on all US imports, potentially rising to 20%. Further, China could be hit with a 60% tariff. Lastly, Mexico may find itself with a 25% tariff. Now, I am not going to cover why and what the positive impacts are, such as bringing production on shore or raising tax revenues, because this discussion is about inflation. Finally, bear in mind that there are already significant tariffs in place, some of which were imposed by the Biden Administration. Get ready, because here it comes. If those proposed new tariffs were to be levied…

Automobile Industry: Trump's proposed 60% tariff on Chinese goods, along with Biden's existing 100% tariff on Chinese-made electric vehicles, would significantly impact the automobile industry, particularly electric vehicles (EVs) and their supply chains. European manufacturers like BMW, Volkswagen, and Mercedes-Benz could also face renewed tariffs, adding strain to the sector as well as driving up Core Goods CPI.

Consumer Electronics (Consumer Discretionary): A universal 10% tariff on imports, combined with existing Chinese tariffs, would increase costs for companies like Apple, Microsoft, and Tesla (Tesla used Chinese-manufactured parts). The consumer electronics industry, heavily reliant on imported components, would see production costs rise, potentially reducing profit margins. The reduced margins would be passed along to consumers causing Core Goods Inflation

Machinery (Industrials): The machinery industry would face rising costs due to a universal 10% tariff on imports, coupled with existing Chinese tariffs. This sector's reliance on imported parts could lead to increased production costs and a squeeze on profit margins. Key companies affected include Caterpillar, John Deere, and Cummins. A decrease in margins there would be passed to customers who may be builders, manufacturers, or farmers. Their decrease margins would ultimately find their way into many areas of CPI.

Agriculture: Proposed tariffs on Mexican imports would indirectly affect U.S. agriculture, as Mexico is a major supplier of fruits, vegetables, and processed foods. Increased costs could lead to higher consumer prices, contributing to food inflation, particularly for fresh produce and processed food items. Additionally, retaliatory actions from Mexico could make it harder for U.S. farmers to export their products, further straining the agricultural sector and exacerbating food supply issues, ultimately causing increases in Food Inflation.

Construction and Infrastructure: Tariffs on steel and aluminum would heavily impact the construction and infrastructure sectors. Developers, infrastructure companies, and construction firms would face rising material costs, leading to delayed projects or higher costs for end consumers. This can also have an impact on Auto Manufacturing margins. All of these increased costs will find their way into Goods Inflation, and though I have avoided discussing it up until now, Housing Inflation (which is found under Service CPI).

Retail and Consumer Goods: A universal tariff would also affect virtually all retail sectors that depend on inexpensive imports, such as clothing, electronics, and household items. Retailers like Walmart and Target would need to either absorb these increased costs, impacting profit margins, or raise prices effecting, ultimately, Goods Inflation.

Now, let's take a step back. This is not an exhaustive list, but simply, and hopefully enough to demonstrate how potentially damaging inflation could be. I will also add that not all companies may be - um, rational. Some may decide to maintain prices and eat cost increases. This will allow them to maintain demand, but it will come as a cost to stock investors, who don't take kindly to margin compression.

If you look carefully at the first chart above, you will notice that goods prices did climb somewhat, in the wake of the 2018 tariffs. Will that happen again? Will it look similar? Well, this time it is different. Pay close attention to this morning's release! And pay attention to those tariffs which are largely expected in one way or another starting in January. The Fed is certainly paying attention, so we can expect any numbers hotter than the consensus could affect the Fed's December rate policy, and, in the very near term, longer maturity bonds and stocks, which may both find themselves under pressure.

YESTERDAY'S MARKETS

NEXT UP

• Consume Price Index / CPI (October) may increase slightly to 2.6% from 2.4%. This WILL be top of mind and can determine the mood for your evening commute.
• Fed speakers today: Kashkari, Williams, Logan, Musalem, and Schmid.
• Earnings after the closing bell: Tetra Tech and Cisco Systems.

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