Economists are once again predicting that inflation will accelerate as a result of tariffs. If that were to happen, it could push off expectations for the next rate cut from the Fed. But, economists have also been predicting inflation that hasn’t actually manifested for months now. How things shake out on Tuesday could change the outlook for the Fed and move the dollar substantially.
Markets are showing increasing doubts that the Fed will actually deliver a rate cut in September. A week ago, there was about a two-thirds chance of a cut, but that has since shifted to chances in the 50% range. It wouldn’t take much, presumably, to push that percentage down just a little and push expectations for the rate cut to October.
The Dollar-Rates Divergence
Normally higher rates would imply that the currency gets stronger. But the worry is that if the Fed doesn’t cut, then the economy will slow and that will make investing in dollar-backed assets unattractive to investors. Thus, the dollar would likely weaken. Meaning that in the opposite scenario (that inflation cools) the dollar could be revitalized.
Fed Chair Jerome Powell said earlier this month that if it weren’t for the expected inflation impact of tariffs, then they would be cutting rates now. Meaning that it’s crucial for the evolution of the dollar whether or not it becomes apparent that tariffs are (or are not) driving inflation. So far, things are a little muddled. But, as time goes on, one of the two options will become increasingly apparent.
Another Prediction of a Rise
Inflation did tick up in May, but not at the rate that economists had predicted. It was the first tick up in inflation since the start of the year. Economists are expecting that upward trend to accelerate, pointing to a broad range of prices increasing as a result of tariffs. In other words, the inflation is expected to be concentrated in primarily manufactured goods. But also, it’s worth remembering that the dollar has lost around 10% since the start of the year, and that would also have an impact on imported prices, regardless of tariffs.
Those increases are expected to be bigger than other deflationary pressures that are expected. Housing costs are predicted to have fallen, as well as the cost of new cars. Consumers rushed to buy vehicles ahead of the tariffs, which means lower demand in the last month. But, there isn’t a tidy reconciliation of just who and how much is passing through the cost of tariffs on to consumers. For example, Nike announced it was raising prices on some goods as a result of tariffs. Meanwhile, Walmart said it was seeing margin compression as it was not passing on higher costs to consumers. Yet.
What’s Expected
The consensus among analysts is that US June headline annual CPI change will accelerate to 2.6% from 2.4% prior. The core rate is expected to rise to 2.9% from 2.8% prior. That’s moving away from the Fed’s 2.0% target, and would be the second consecutive month of increase.
Both the Fed and the market are still expecting two rate cuts this year, for September and October. But, if inflation undershoots, then a third rate cut for December might come back in. On the other hand, if inflation is hotter than expected, it could push off that second rate cut. Both outcomes would likely end up causing an important move in dollar pairs.