Many investors and traders are still optimistic that U.S. inflation will go down when the consumer price index for June comes out on Thursday. At the same time, Wall Street is talking about how a second term for Republican Donald Trump could make prices go up.
Before the CPI report comes out in a few days, two different ideas are forming about where U.S. inflation is likely to go in the coming months and years. This makes it harder for the Federal Reserve to figure out the best way to raise interest rates, which are still at 23-year highs of 5.25% to 5.5%. The DJIA SPX COMP and the S&P 500 and Nasdaq Composite both set new highs as the market closed on Tuesday. This was despite a selloff in U.S. government debt that caused 10- and 30-year Treasury yields to rise for the first time in five sessions.
Some people think that as U.S. growth slows, inflation will likely keep going down. This would allow the Federal Reserve to lower interest rates as soon as September. Economists think that the annual headline CPI inflation rate will drop from 3.3% in May to 3.1% in June. Traders in inflation think that the rate will keep falling toward 2% until May 2025.
Something else that people think is possible is that inflation could start up again if Trump wins the election because of his plans for trade and immigration. The fear of Trump 2.0 was shown by a two-day rise in Treasury yields on June 28 and July 1. This happened even though Americans still have four months to vote.
The traders like to connect Trump’s plans for policy with inflation for good reasons, said Thierry Wizman, a global FX and rates strategist at the financial services company Macquarie based in New York. “They think that in Trump 2.0, policy rates will be higher than they would be otherwise.”
Trump is ahead of Vice President Joe Biden in the polls almost two weeks after their June 27 televised debate. This has made the Republican challenger’s plans for 10% tariffs on all imports and minimum 60% tariffs on Chinese goods the center of attention. To be fair, Biden is also mostly to blame for the rise in U.S. inflation that started in 2021 and reached its highest point in 2022, thanks to his plan to help COVID patients, which required the government to spend an extra $1.9 trillion.
Jan Hatzius, chief economist of Goldman Sachs GS, +1.72%, said last week at the annual meeting of the European Central Bank in Portugal that Trump’s plan for 10% tariffs could lead other countries to take similar actions. When the possible trade war was taken into account, Hatzius thought that it would cause U.S. inflation to rise by 1.1% and lead to five extra quarter-point rate hikes by the Fed.
Also, Steven Zeng, a strategist at Deutsche Bank DB, -0.42%, has pointed out that Trump’s immigration policies are likely to have an effect on U.S. interest rates. In the short term, Zeng said, more immigrants have “acted as a positive supply shock and helped the Fed’s ability to cut rates.” “As a result, a change in these flows could lead to higher wage inflation and the Fed becoming more “hawkish.”
Fed Chairman Jerome Powell’s first day of testimony in Congress ended on Tuesday. Following this, traders in fed-funds futures put a 70% chance of a quarter-point rate cut by September.
Even though the market thought the Fed would cut rates in September, inflation trader Gang Hu of WinShore Capital Partners in New York said, “I don’t see them cutting at all in 2024.” People are waiting for the June CPI report on Thursday, and Powell has said again that we need to see more signs of inflation slowing down. But Hu said that the Nov. 5 election result “could drastically change everything, so the Fed needs to tread carefully.”
“Trump is the only thing that matters right now.” “That’s the main point, and the Fed can’t ignore the possible election results in any way,” Hu said on the phone. When it comes to inflation, the next three to four years could be very different because of the election. And some people in the market are already being scared about that picture.
The Federal Reserve’s job is to keep inflation in check, so policymakers will likely have to think about how Trump’s tariff plans and call for immigration reforms might affect the economy. People have thought that immigrant workers have helped the U.S. job market by filling positions where it has been hard to find workers. Trump has also said that he wants to deport millions of undocumented workers.
Tuesday, Powell stayed out of a line of questioning from a lawmaker that was mostly about Trump’s plans for tariffs. Then, when asked about inflation in the 1970s, the head of the Federal Reserve said that “inflation kept coming back” even though price increases had been stopped. Powell also said that the current trend of inflation has been marked by supply shocks and demand shocks caused by the U.S. economy’s reopening after the COVID-19 pandemic.
“The Fed is not going to talk about Trump’s policies in any way,” said Derek Tang, an economist at Monetary Policy Analytics in Washington. As an alternative, policymakers will try to play it safe by saying that Covid’s predictions are uncertain. They will then use this to hide any risks related to Trump before the November 5 election.
Tang said on the phone on Tuesday, “It’s clear that politics affects the economic forecasts for 2025 and 2026, but the Fed is going to act like it doesn’t. That’s the gray area they are operating in.” It comes down to the question of “Should they cut rates if the spot data says yes but the forecast says no? The forecast is a guess about who will win the election.” My guess is that policymakers will start to loosen up by September or December. If they need to change their minds and raise rates, they will, which could make things even worse by making investors confused.
