Early data shows the disinflationary impact of tariffs
While many have concluded that tariffs will only serve to push inflation higher, early data shows the opposite effect.
While US tariff policy has left many investors and the Federal Reserve concerned about the implications for the inflation outlook, early data is showing the disinflationary impact of tariff policy.
For while durable goods prices have risen somewhat in recent months, the impact on consumer confidence and spending intentions has contributed to a major reduction in the pace of services price growth.
With services making up a far greater proportion of the CPI/PCEPI (PCE Price Index) equation, the inflation rate has thus not only continued its downward trend, but has shown an additional marked deceleration since February.
CPI services categories that are discretionary in nature have seen particularly major decelerations in price growth. This includes airfares (YoY change of -7.9% in April versus -0.7% in February), other lodging away from home including hotels and motels (YoY change of -2.3% in April versus 1.7% in February) and recreation services (YoY change of 3.6% in April versus 4.3% in February).
Overall adjusted supercore services price growth (i.e. excluding lagging shelter, indirectly measured health insurance and inconsistently measured categories) has now fallen to 2.8% YoY, which represents the slowest pace of growth seen since March 2021 and a major decline from the 3.9% growth rate recorded just two months ago.
While the potential tariff impact has not yet been fully felt, apparel price growth has also fallen to -0.7% YoY in April, from 0.6% in February, marking the steepest YoY decline seen since March 2021 and further highlighting the impact of reduced consumer confidence and the ongoing downtrend in cotton prices.
Sticking with commodity prices, it’s also critically important to note how the economic uncertainty stemming from tariff policy has hit oil prices, which has contributed to the CPI energy commodities index declining from -3.2% YoY in February, to -11.5% in April.
Delving into the PPI shows even larger hits to services price growth, with MoM growth in the final services category plunging by -0.68% MoM in April, which is the largest drop on record for the data series that dates back to December 2009.
This saw the 3-month annualised growth rate fall to -0.54%, the lowest reading seen since June 2020.
While some of the decline was driven by lower trade services margins, the elevated level of a key proxy for corporate profit margins suggests that there’s significant further scope for businesses to absorb at least some of any increase in input costs.
Though even when excluding the impact of trade services margins, the services ex-trade, transport and warehousing index fell by the largest amount since April 2020, declining by 0.29% MoM.
3- and 6-month annualised growth fell to 1.7% and 2.7% respectively, levels not seen since July and September 2022, respectively.
Given the impact of significantly lower services price growth and declining apparel and gasoline prices, the PCEPI recorded MoM growth of just 0.10% in April, with these categories combining to significantly offset the 0.48% MoM increase in durable goods prices (which was the fastest MoM increase seen since August 2022). The moderate headline PCEPI growth rate follows a MoM increase of just 0.01% in March.
Core PCEPI growth came in at just 0.12% MoM, following an increase of 0.09% in March, while supercore PCEPI growth (i.e. core less housing services) saw MoM growth of just 0.06%, following an even smaller rise of 0.03% in March.
The slowdown in MoM growth has seen headline PCEPI growth fall to within a whisker of the Fed’s 2% target, with YoY growth hitting 2.1% YoY in April, down from 2.6% in February. Meanwhile, core PCEPI growth has fallen to 2.5% YoY, its lowest level March 2021 and down from 2.9% in February. Supercore PCEPI growth fell to 2.2% YoY, also down significantly from February’s level of 2.6%.
In conclusion …
While it’s still very early days, and it remains unclear where tariff rates will settle and how it will impact goods prices and the overall inflation equation, this analysis clearly highlights the need to remember that the inflationary impact of tariffs isn’t a one-way street. Instead of pushing prices higher, the initial impact has likely been to push inflation lower.
When thinking about the medium-term impact, when one considers key factors, it remains firmly within the realm of possibilities that Trump’s tariff agenda continues to push inflation lower, which would have significant implications for interest rates and asset prices.
While the medium-term impact of the Trump administration’s tariff policy is worthy of its own separate article – stay tuned – some key offsetting factors to higher prices include:
Reductions to consumer confidence and spending intentions will act to put downward pressure on prices.
Services prices make up a far larger portion of the CPI and PCEPI.
Housing services price growth is likely to continue to fall.
Nondurable goods are produced in significant quantities within the US and some may see downward price pressure from the impact of tariffs on economic growth (most notablly oil and gasoline).
Corporate profit margins remain historically elevated, suggesting scope for businesses to significantly absorb cost increases.
The M2 money supply isn’t growing at a rate that will allow businesses to easily pass on cost increases.