That being said, one Wall Street firm is going against the crowd by believing what new President Donald Trump says about tariffs. This firm now thinks that U.S. consumer prices will likely experience a “permanent shock” and the Federal Reserve will need to keep interest rates higher than they would be otherwise.
One of twenty primary dealers that trades with the Federal Reserve’s regional bank in New York is BNP Paribas BNP -1.12%, based in Paris. The bank said it thinks Trump will keep “most if not all his campaign promises on foreign, economic and trade policy,” even those that could hurt the U.S. economy, like putting tariffs on imports.
It also said, “In this way, our analysis differs from what we see as the implicit market assumptions that underlie current pricing.”
In other words, stock prices have hit all-time highs in the last two weeks. On Wednesday, the Nasdaq Composite closed above 20,000 for the first time ever. Also, traders in fed-funds futures are betting on as many as four quarter-point rate cuts by the Fed until the end of the year. This comes after next week’s widely expected cut. For the next five, ten, and thirty years, market-based estimates of inflation have also gone down from where they were on Nov. 6, the day after the election. These are called breakeven rates.
Many people in the market are still hoping that Trump’s tough talk on tariffs is just a way to get what he wants in negotiations.
A 2025 Global Outlook report released by BNP on Thursday says that if people believe what Trump says, the U.S. economy may not recover from its impending soft landing in early 2025 and instead stop growing until 2026. This is because Trump’s policies on tariffs and immigration will become law, making his pro-growth plans less effective. The bank also thinks that people in the market will start to price in higher U.S. inflation and fewer rate cuts from the Fed than they do now.
“Some people say that Trump’s policies, especially tariffs, won’t cause inflation because (i) he won’t put them into action, (ii) the dollar will completely cancel out the effect, and (iii) there won’t be any second-round effects.” According to the BNP study, “we think this framework is wrong.” “We think Trump will carry out large parts of his tariff threat, even if not all of them.”
BNP also said, “We expect a permanent shock to the level of consumer prices in the U.S. [around 2 percentage points], as well as a temporary effect on U.S. inflation over the next two years.” But we don’t think that predictions of inflation will change. That is, we think that the U.S. Federal Reserve keeps long-term inflation predictions in check by keeping policy tight for longer than it would normally be the case.
Here are some of the ways BNP is thinking about the coming year:
- Tariffs that Trump wants to put in place could cause prices to go up by about 80 basis points on their own. “However, tariffs have an impact on inflation through two main ways: first, they raise the prices of imported goods; second, they have effects on the overall price level.” According to BNP’s model, when the prices of imports go up, they affect many other goods, services, and pay. These effects are made stronger by short-term momentum.
- As long as the central bank cuts rates by 25 basis points next week, the upper end of the Fed’s main interest rate goal should stay at 4.5% for all of 2025. At the moment, the goal for the fed-funds rate is between 4.5% and 4.75%.
- Two-year Treasury yields (TMUBUSD02Y +4.193%), ten-year Treasury yields (TMUBUSD10Y +4.330%), and thirty-year Treasury yields (TMUBUSD30Y +4.551%) could end 2025 at 4.55%, 4.65%, and 4.8%, which are all higher than where they are likely to be in the first quarter of next year.
- Against the Chinese yuan (USDCNY +0.08%), the Mexican peso (USDMXN +0.30%), and the Canadian dollar (USDCAD +0.34%), the dollar DXY +0.20% could go up even more. Trump wants to put an extra 10% tax on goods coming from China and a 25% tax on goods coming from Mexico and Canada.
- Gold prices should stay low until the second half of 2025, even after they reach new highs in the first few months of that year. This is because the dollar is stronger and the Federal Reserve is still on hold.
- As tariffs start to take effect in the second half of 2025, crude oil prices are expected to fall CL00-0.21% BRN00 +0.15%.
More signs have come up in the last week that U.S. inflation will be harder to fight than many people thought. The consumer price index for November released on Wednesday showed that the yearly headline CPI rate went back up to 2.7% from 2.6%. And on Thursday, the overall producer-price index for November came in at 0.4%, which was higher than expected and twice what the Wall Street Journal asked economists to think it would be.
After the producer price data came out Thursday morning, two- to thirty-year Treasury yields were slightly higher in the afternoon trade. At the same time, all three major stock indexes—DJIA -0.51% SPX -0.39% COMP -0.40%—went down. The Nasdaq Composite fell from its record close level of 20,034.89 on Wednesday.
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