US tariffs act like an adverse supply shock

US tariffs act like an adverse supply shock, as the implications are likely to be lower growth than would have existed in the absence of tariffs and higher inflation. The question for the Fed, and hence for the market, is whether the order of magnitude is sufficient to either make the Fed eager to ease further and faster, should the growth effect dominate, or more determined to pause – or even hike again – if higher inflation is the primary outcome.

For now, it seems likely that both the Fed and the bond market will be cautious about jumping to conclusions, not least because tariffs could be removed just as fast as they were imposed. Market-implied pricing of future Fed policy has not changed significantly since the weekend announcement of tariffs, although that might be because the market has been slowly pricing in the implications of tariffs for some time now.

“We have not changed our views on the Fed at this stage. We still believe that the Fed will stay on hold until the latter stages of Q2 and cut rates three times in all this year. The bond market has also reacted to the tariffs in a rather restrained way which is also indicative of the idea that, as a supply shock, tariffs are likely to produce lower growth and higher inflation. Again, our views have not changed materially when it comes to the treasury market as we still see 10-year yields pushing up to the 5% region over the next few months”, said Steven Barrow, Head of Standard Bank G10 Strategy.

Much here will probably depend on whether the market detects more adverse growth implications from the tariffs in survey data, such as PMIs, or a bigger uplift in price measures again from the same survey data. The former could help lower yields, while the latter might produce higher rates. This Friday’s payroll data for January will cover the pre-tariff period, of course, and we think that the 170k consensus is too low. However, benchmark revisions are likely to show, once again, that payrolls are routinely overstated given that the March 2024 figure is expected to be revised down by around 700k workers.

The Bank of England will be the first G10 central bank to make a decision on policy rates since US tariffs were announced. Steven Barrow suspected that the tariff issue won’t make much difference to the outcome of the BoE’s meeting, which we see as a 25-bps rate reduction. The lower rates are justified even before any account is taken of the uncertainty created by US tariffs.

The key here is that data on current and expected wage awards continues to decline. Of course, official average earnings data still shows that non-bonus wages are rising at an annual rate of 5.6%, which is quite elevated. But concerns over the accurateness of official labor market data, combined with the much lower wage award data suggested by private sector surveys implies that most wage awards will be in the 2-4% range this year; a rate that seems conducive to lower base rates in our view.

In addition to this, the Bank will know that business confidence is in a pretty parlous state even before the US’s tariff imposition and it will not take much disturbance from overseas to really tip things over the edge. The UK could already be flirting with a recessionary environment with growth of zero in Q3 and Q4 not looking much better. “We not only think that the base rate will be cut 25-bps this week; we also believe that base rates will be trimmed by a further 100-bps this year to leave the policy rate at 3.5% come year end”, said Steven Barrow.

Will other central banks outside the US intensify their monetary easing as a result of US tariffs? To some extent central banks will have been prepared for the higher levels of uncertainty that come with a Trump presidency. The Bank of Canada has eased policy aggressively and part of this may have been because of its concerns south of the border. The Reserve Bank of Australia could be hurried along to ease policy as a result of US tariffs and the impact they could have on the Chinese economy. A rate cut from the RBA later this month, the first in the cycle, looked likely before the tariff announcement, but now seems an almost nailed-on certainty.