Inflation fears are rising, and new steel and aluminum tariffs could make it worse. Here’s what you need to know.
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Blog post for February 10, 2025
Down to the brass tax. Are you worried about inflation? Are you worried more about inflation today than you were, say, a month, or two ago? Of course, you are. I don’t care how much money you have; nobody likes inflation. And remember, inflation only measures change in prices NOT actual prices. So just because inflation may be lower than it was two years ago, it doesn't mean that prices are less. It simply means that prices are going up at a slower pace (disinflation).
What can an average consumer do to lessen the impact of inflation on their budget? Nothing really. I suppose consumers can simply just stop buying goods and services that are inflating and hope that the decrease in demand will cause the sellers to pull back a bit. That is unlikely to happen in the near term, due to supply chain complexity, and of course, the fact that only an irrational firm would be willing to cut its margin, except in extreme conditions.
Really, the only thing that consumers can do is… wait for it… wait for it… demand higher wages to cover rising costs. Seems simple right? Surprised that I wasted so much time leading up to this simple answer? Don’t be. Remember that there are three types of inflation: demand-pull inflation, supply-push inflation, and built-in inflation. We talk a lot about the former two because they are the most tangible, and understandable ones, but the latter one can be the most devastating. Quick refresher before we move on. Demand-pull inflation is what happens when consumer demand is high and pushes prices higher. Supply-push inflation is when suppliers raise prices because their costs are going up, largely due to supply chain challenges. This is what really sparked the recent inflation cycle as supply chains got mucked up during the pandemic.
Built-in inflation has to do with inflation expectations. This happens when workers expect inflation to be higher, so they demand higher wages. Higher labor costs cause companies to raise prices to consumers in order to maintain margins. Companies also raise prices if they too expect higher inflation in the future. Here is where things get messy. When workers get higher wages, they demand more goods, thus accentuating the inflation problem. So, expected inflation begets inflation which begets further inflation. This is referred to as Wage-Price Spiral by economists, but we common folk may refer to it as a dog chasing its tail. The Fed is extremely worried about this type of inflation because it is hard to control a self-perpetuating cycle. The only remedy for this is draconian rate hiking.
Why am I telling you this? Well, on Friday, we got a very timely University of Michigan Sentiment indicator for February, and it registered a rather extreme and unexpected drop (71.1 to 67.8). The reason? Expected inflation! In fact, as part of the data series, University of Michigan polls inflation expectations, and 1-year expected inflation spiked to 4.3% from 3.3% (economists were expecting it to be unchanged). That is the largest monthly increase since 2023. On a side note, Republican respondents expected no change, with the biggest changes expected by Democrats. Regardless, Democrats are still consumers and if they are worried about higher inflation… well, you know. 👆🙃 The Fed could not be happy with Friday’s number, and it played a big role in Friday’s decline in the equity markets.
Over the weekend, WHILE YOU ATE TOO MANY CHICKEN WINGS, President Trump dropped another tariff bombshell on reporters traveling with him on Air Force 1. The President said that he would be announcing a 25% tariff on Steel and Aluminum imports to the US. The full, official announcement is expected today, along with further counter-tariffs later this week.
Assuming we get this announcement today, here is what you need to know. The US imports approximately 25% of its steel consumption and 50% of its aluminum consumption. The top three steel importers are Canada, Brazil, and Mexico. The top three aluminum exporters to the US are Canda, China, and Mexico. Regardless of where the commodities come from, it is US companies that will have to pay the tariffs. So, think about all the items in your home that contain either aluminum or steel, from your garage to your kitchen, to the structure itself. All of those items are likely to become more expensive as a result of these tariffs, IF they are enacted. This would be supply-push inflation.
BUT they didn’t go into effect yet. In fact, they weren’t even technically announced yet. However, we heard it from the President’s mouth, and obviously at least 45% of Americans are already EXPECTING high inflation (percentage of Democratic voters) according to the University of Michigan survey. The announcement of these tariffs will only amplify those fears, whether they happen or not. This is where built-in inflation comes in.
One final word on these newly expected tariffs. The cost increases in steel and aluminum will quite likely cause buyers to seek alternative, cheaper sources, and the only country where steel and aluminum will be 25% cheaper is—you guessed it—America. This is likely to bring demand back to local producers. According to the best data I could find, US steel producers are running at around 75% capacity, and Aluminum at around 55%. This suggests that sourcing shifts could possibly abate the cost increases somewhat, however it is important to recognize that these producers can’t quickly ramp up production, so at the end of the day it is reasonable to assume that there will be some negative fallout. Finally, as we have learned in the past, announcements of tariffs doesn’t necessarily mean that they will actually go into effect. And it is important to note that President Trump enacted Steel and Aluminum tariffs in 2018 (25% and 10% respectively). Some of those tariffs were lifted a year later while some form of them are still in effect today.
How will the market react to the news? Well, markets have been surprisingly resilient to tariff news so far—perhaps traders expect them to be used as a threat which ultimately will lead to postponement or renegotiation. This may be true for now, but the fact that consumers are anticipating inflation, will ultimately cause inflation, and we know that the Fed and the markets don’t take kindly to inflation.
FRIDAY’S MARKETS
Stocks declined on Friday in response to a deluge of economic information and the ongoing threat of more tariffs. Jobs data came in light, but significant upward revisions from the prior 2 months painted an overall strong employment picture, adding to the Fed’s “done for now” case. Consumer sentiment took a huge hit in the latest report from University of Michigan.
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