The Trump tariffs—now fully in effect on imports from Canada, Mexico, and China—have already begun reshaping the U.S. economic landscape. Evidence suggests that these protectionist measures are contributing to an economic slowdown, higher consumer prices, and rising unemployment. Given these dynamics, the Federal Reserve will likely lower interest rates sooner than later to fulfill its mandate of achieving maximum employment—even if doing so means tolerating some inflationary pressures.
Tariffs as a Tax on Consumers and Businesses
Tariffs effectively act as an additional tax on imported goods. Sectors such as food and energy, which rely heavily on imports from neighboring countries, are feeling the pinch as costs rise. For example, while popular narratives suggest that Mexico supplies 50% of certain produce, detailed USDA data indicate that only about 35% of U.S. fresh vegetable availability is imported, with roughly 70% of that value sourced from Mexico. This nuanced view means that while the headline numbers may appear dramatic, the real impact is a measurable increase in prices for key staples without completely displacing domestic production.
Analyses by institutions like PIMCO estimate that the tariffs could raise U.S. inflation by approximately 0.8 percentage points and reduce GDP growth by about 1.2 percentage points in the first year. The added cost burden and reduced growth set the stage for a broader economic contraction.
Corporate Hesitance and Supply Chain Disruptions
Facing higher input costs and supply chain uncertainties, many CEOs are postponing new investments. This hesitancy translates into slower production and delayed expansion plans, which, in turn, reduce hiring. The disruption of long-established supply chains further compounds these issues as companies scramble to source alternatives. The net effect is a slowdown in economic activity and a rising unemployment rate as businesses adjust to the new, costlier environment.
Why the Fed Will Lower Interest Rates Sooner
Even though tariffs inherently raise prices, the Federal Reserve’s dual mandate requires it to maintain both price stability and maximum employment. Here are key reasons why the Fed will have good reason to lower rates in this environment:
- Mitigating Rising Unemployment: As businesses cut back on spending and investment, job losses become more likely. Historical evidence shows that when economic activity slows and unemployment rises, the Fed has responded by cutting rates to stimulate borrowing, spending, and investment. The increase in unemployment risks deepening the economic slowdown, and the Fed’s primary objective of maintaining full employment makes rate cuts a necessary tool—even if inflation remains elevated.
- Stimulating Aggregate Demand: Lower interest rates reduce the cost of borrowing for both consumers and businesses. This, in turn, can help boost consumer spending and corporate investment, countering the slowdown induced by tariff-driven cost increases. By making financing cheaper, the Fed aims to revive economic activity and support job creation.
- Preventing a Downward Spiral: A significant slowdown in economic growth can trigger a negative feedback loop where reduced spending leads to lower production, further layoffs, and even more subdued demand. In such a scenario, the Fed’s proactive rate cuts can help break the cycle by providing a monetary stimulus that encourages economic recovery.
- Balancing the Inflation-Employment Trade-off: While tariffs are inflationary, the Fed is prepared to tolerate a temporary rise in inflation if it means avoiding a recession and significant job losses. The Phillips Curve framework illustrates a trade-off between inflation and unemployment, and with full employment being a central goal, the Fed is likely to lean toward easing monetary policy in the face of rising unemployment.
- Historical Precedents: Looking back at past economic downturns—such as the Great Recession—rate cuts were used effectively to stabilize the economy and preserve jobs. Similarly, the current mix of slowing growth, rising prices, and increasing unemployment provides strong justification for a preemptive monetary easing to cushion the impact of the tariffs.
Conclusion
The Trump tariffs, now in full force, are doing exactly what they were destined to do—drive up prices, curtail corporate investment, and usher in a charming era of higher unemployment and sluggish economic growth. In this marvelously counterintuitive scenario, the Federal Reserve finds itself under ever-mounting pressure to lower interest rates sooner than many had hoped. Sure, tariffs were championed as the savior of domestic industries, but their unintended domino effect on the broader economy leaves policymakers with little choice.
Enter Jerome Powell—ready to swoop in like Superman. With full employment and robust aggregate demand as his guiding principles, Powell is poised to rescue us from the looming recession. Despite the pesky inflationary risks that tariffs bring, the imperative to keep jobs flowing and the economy humming makes a rate cut not just a possibility but a necessity. In short, while tariffs may have been designed to shield our industries, their collateral damage practically writes the Fed’s next chapter in heroic fiscal intervention.
Remember I said this? This will be another “I told you so.” When it’s clear he is coming off the sidelines sooner than later, the market will rally again. That more than likely is several months away. (After a long summer, more than likely.)
The Washington playbook outlined above is expected to unfold over the coming months. In the near term, stock prices are likely to remain highly volatile, with valuation pressures pushing a bias to the downside. However, the outlook for the third and fourth quarters appears more promising. With rising incomes and increased savings—and the 10-year Treasury yield trending lower, a trend that is anticipated to continue—there are clear signs of improving long-term economic fundamentals.
Lower yields will boost the affordability of homes by easing borrowing costs. This should help alleviate the current shortage of existing homes in a market where demand remains robust while also spurring new residential construction. In the commercial sector, a lower yield environment could help stabilize real estate markets for banks that were forced to opt for loan forbearance during the COVID crisis rather than incur massive lease losses—a striking reminder of how quickly market conditions can change.
Moreover, it’s important to note that the President, who has frequently championed lower interest rates during his campaign, has strategically shifted his rhetoric to target the 10-year Treasury yield. Given his background in real estate, his focus on this key benchmark is designed to bolster the housing market and overall economic activity. If these developments play out as expected, it will confirm that strategic targeting of market fundamentals can help reverse the short-term volatility caused by tariffs, setting the stage for a healthier economic environment.
Buy the Dip?
In my opinion, current market conditions warrant extreme caution. What I see is the FOMO players buying the dip, NOT THE SMART MONEY. Below is yesterday’s trading on the S&P 500. Notice how the market started to rally off the lows of the day around 12:30. It was looking like a possible reversal for the day. But 37 minutes before the close, the market reversed and met with “smart money selling,” with the index closing closer to the low of the day than the high. A classic smart money move. On a reversal, traditionally, you want to see the index close near the high, not the low. A classic bull bear tug of war. With valuations high, tariffs, policy uncertainty, lower bond yields, and CEO uncertainty, I see the smart money winning this tug of war. Below is the S&P 500 chart from yesterday.
Final Thought
Right now is not the best time to take positions unless you feel something is tremendously undervalued or you plan to day trade the particular security.