Where’s the Slowdown?
Ever since the trade war began under Trump 2.0, the consensus expectation among top-down forecasters has been a growth slowdown and not a recession. The BoA Global Fund Manager Survey shows that stagflation, or below-average growth and above-average inflation, is the overwhelming consensus.
To be sure, it takes time for the effects of tariffs of reduced operating margins and higher prices to show up in the economy. We are already in the third month of tariff implementation. The U.S. economy remains resilient from a top-down perspective. The Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has risen from negative to positive. Where’s the slowdown?
Discussions of tariffs have dominated earnings calls, and both companies and investors are exhibiting high levels of tariff anxiety.
From a bottom-up perspective, the market is displaying a surprising level of resilience. EPS and sales beat rates are above their historical averages. The Street’s forward 12-month EPS estimates keep rising. Where’s the slowdown?
Tariff effects on earnings appear to have been the exception rather than the rule. Outside of a few exceptions in autos such as General Motors and Stellantis, or Nike, most companies haven’t highlighted tariffs as a headwind in their earnings reports.
Policy Uncertainty = Timing Uncertainty
Investors may be overly impatient about the timing effects of tariffs on the economy. Tariff implementation has been affected by changing policy and the leads and lags of front running.
It is clear that the threat of tariffs has affected corporate behaviour. It’s also clear that consumers face an overall average effective tariff rate of 20.2%, a 17.8% increase from 2024 and the highest since 1911. The projected consumers and businesses shift spending in reaction to the new tariffs and is modeled to average 19.3%, the highest rate since 1933.
In the short run, tariff implementation has sparked rapid adjustments owing to the volatility of announcements.
Businesses responded to the volatility of announcements by front-running imports and accumulating cheaper inventory ahead of tariff implementation dates. Container shipping rates from China to the U.S. have experienced a high degree of volatility in 2025. They initially fell as fears of a trade war began in February, but surged on the news of the trade truce negotiated by Treasury Secretary Bessent in Switzerland, and fell again.
A Slow Motion Slowdown
In reality, the effects of tariffs on the economy are not being fully felt because of inventory front running. On average, the S&P 500 company holds three months of inventory. In practice, that figure may be slightly higher because of front-running effects.
Tariff revenue only began to rise in April and it has been steadily increasing ever since. Counting forward three months, investors should begin to see the preliminary effects in the July–September time frame, which would be reflected in Q3 earnings. That may be the reason why the economy appears to be resilient.
Recent trade deals, such as the latest with Japan, Indonesia and the Philippines, have buoyed investor sentiment. The reality is tariffs are not going away as they are needed to offset the growing deficits in Trump’s One Big Beautiful Bill Act (OBBB Act). The nonpartisan Congressional Budget Office warned that the OBBB Act will add $3.4 trillion to U.S. deficits.
Monetary Policy Implications
Here is how I expect tariffs to affect monetary policy. Current market expectations call for two quarter-point rate cuts in 2025, with the first occurring at the September FOMC meeting.
Already, investors are seeing the early effects of tariffs on PCE inflation in import prices. It remains to be seen how persistent the price increases will be, and the degree at which companies will pass through the increases.
On the other hand, the Fed will also have to be concerned about the other side of its dual mandate of price stability and full employment. As Baby Boomers retire and immigration rates decline, the breakeven rate at which Nonfarm Payroll Employment needs to keep the unemployment rate from rising is sharply falling.
How these cross-currents evolve in the coming months will largely affect the Fed’s interest rate policy. Stay tuned.