The announcement of the reciprocal tariff plan comes against a backdrop of worsening economic data which has been the key factor behind the change in financial market reaction to tariff news from US dollar supportive to dollar negative.
Might President Trump come to regret the change in sequencing of policy implementation? In his first term in office, tax cuts came first, tariffs second. The economy now is certainly more vulnerable although we see that as more than just down to policy sequencing. The US economy is at a different point in the economic cycle than in 2017-19 which likely means a lot more damage for the economy from tariffs this time around.
That was evident yesterday with the ISM manufacturing report underlining the deterioration in business sentiment in anticipation of tariffs being implemented. While the overall ISM manufacturing index fell modestly from 50.3 to 49.0, the New Orders index fell sharply from 48.6 to 45.2. Over a 2-month period, new orders have fallen by the most since 2012 when the covid period is excluded. The Prices Paid index surged by 7.0ppts and again over a 2-month period the jump was the largest since January 2021 ahead of the global inflation shock.
If this mix of economic data persists, what would it mean for the FOMC? There would surely be greater initial risks of the FOMC delaying a decision to cut rates again. Market pricing implies a still high degree of confidence of a rate cut in June (80% probability) but whether the FOMC will have had enough inflation info to be confident of only a temporary impact from tariffs is questionable. Chicago Fed President Goolsbee stated yesterday in an interview that tariff-related uncertainty “is tinged with fears over inflation” given it will be difficult to determine how lasting an inflation impact might be.
We still expect the FOMC to cut two-to-three times this year although there are risks that the FOMC could delay longer than implied by market pricing and that could add to the potential for the dollar to recover over the coming months.
