Tariff Pain Still to Come: Economic Reset Unfolds Despite Market Optimism

The worst tariff impacts haven't hit yet, with current rates at just 6% versus the administration's 18% target.

Key Takeaways

• US-China trade relationship entering deliberate reset phase with expected volatility along the way
• Current tariff rates significantly below administration targets, suggesting economic pain still incoming
• Court challenges to tariff authority could force more structured, predictable trade policy implementation
• Labor market showing resilience through slower hiring rather than mass layoffs post-pandemic
• Federal Reserve likely pushing first rate cut to September amid mixed economic signals
• CBO analysis suggests tariffs could reduce deficit by $2.8 trillion over decade with minimal growth impact
• Manufacturing employment barely contracted despite being most exposed to tariff pressures
• Budget process deliberately excludes tariff revenues to maintain presidential policy discretion
• Businesses adopting cautious pricing strategies while holding onto workers due to pandemic hiring scars

US-China Trade Relations Enter Strategic Reset Phase

• The administration is pursuing a comprehensive reset of US-China economic relations, marking a departure from previous agreements that went largely unimplemented under earlier Trump policies. This reset involves much more focused leadership from the Treasury Secretary and US Trade Representative who are determined to ensure Chinese compliance with any new arrangements.
• Recent disputes over rare earths and AI restrictions represent typical volatility expected during this reset process, not fundamental breakdowns in negotiations. The administration identified rare earth access as critical after recognizing that US car manufacturing could halt within weeks without these materials, forcing urgent resolution of supply chain issues.
• Trump's initial 145% tariff proposal represented "mutually assured economic destruction" that proved unsustainable for both economies. The US faced immediate shortages of goods and spare parts while China experienced riots around export factory regions, forcing both sides toward more rational positioning.
• Long-term trajectory points toward a more balanced economic relationship, though expect continued "spats" and negotiations as both sides work through decades of accumulated trade imbalances and structural issues.

Legal Challenges Shape Future Tariff Implementation Strategy

• Current tariff authority faces significant court challenges that could fundamentally alter how trade policy gets implemented. A lower court recently struck down the administration's reliance on emergency authority, though the decision was stayed pending appeals that should conclude by month's end.
• If courts ultimately limit presidential tariff discretion, the administration would need to rely on traditional trade protection acts requiring public comment periods and more structured processes. This would slow implementation but create more predictable business environment with clear procedural requirements.
• Appeals could extend to the Supreme Court, potentially taking up to a year for final resolution. During this period, businesses face continued uncertainty about both the scope and timeline of additional tariff implementation.
• Even with legal constraints, political pressures from midterm elections in November next year will likely moderate tariff aggression. Trump's approval ratings improved following recent tariff policy reversals, suggesting sensitivity to voter reactions on trade issues.

Budget Dynamics Reveal Strategic Tariff Revenue Planning

• The administration deliberately excluded tariff impacts from budget legislation to preserve complete presidential discretion over trade policy implementation. This unusual approach involved weekly White House meetings between Treasury Secretary Bessant and Republican congressional leaders to coordinate budget strategy.
• CBO analysis found that tariffs could reduce the federal deficit by $2.8 trillion over ten years, more than offsetting the $2.4 trillion deficit increase in current budget law. Remarkably, CBO projects this revenue increase would reduce GDP growth by only 6 basis points annually over the decade.
• Inflation impacts from tariffs appear minimal in CBO projections, with PCE expected to rise just 40 basis points in 2025-2026 before returning to baseline. This benign assessment validates Trump's argument that tax cuts could be funded through tariff revenues.
• The debt ceiling becomes binding in August according to Secretary Bessant, requiring budget and ceiling increases by end of July before congressional summer recess. Originally targeted for July 4th signing, passage now appears likely by month's end.

Labor Market Shows Post-Pandemic Structural Changes

• Employment data reveals businesses reluctant to lay off workers despite economic slowdown, reflecting post-pandemic labor shortage experiences. Companies now prefer reducing hiring rates rather than firing existing employees, fundamentally altering traditional recession patterns.
• Manufacturing employment contracted by only 8,000 jobs despite being the sector most exposed to tariff impacts through import intensity and potential trade partner retaliation. This minimal decline suggests the worst employment effects remain ahead as tariff implementation accelerates.
• Labor market flows across hiring, firing, and voluntary quits have declined structurally since the pandemic. Unemployment held steady at 4.2% even as job creation slowed, indicating balanced supply and demand dynamics rather than deteriorating conditions.
• Immigration restrictions are slowing labor supply growth, making it more dependent on US demographics as the population ages. This creates natural limits on employment growth that help explain stable unemployment despite slower hiring.

Federal Reserve Policy Outlook Shifts Toward September

• Fed officials express primary concern about de-anchoring long-term inflation expectations and second-round effects from tariffs, though current data shows no evidence of these feared developments. Market-based inflation expectations deserve more attention than survey-based measures running at 6-7%.
• Recent airline pricing provides insight into business caution, with airfares down 10% from December as carriers preemptively reduced prices anticipating demand slowdowns. This defensive pricing helps explain continued low services inflation despite tariff pressures.
• September emerges as the likely timing for first rate cuts rather than July, based on labor market resilience and mixed inflation signals. The Fed appears increasingly data-driven rather than following predetermined policy paths as economic uncertainty persists.
• Gradual economic slowdown expected as tariff implementation progresses from current 6% average toward the 18% administration target over the next 3-4 months. Business and consumer confidence deterioration should eventually force Fed accommodation despite current hawkish stance.

The tariff-driven economic reset creates both opportunities and risks, with structural changes in labor markets providing cushioning while policy uncertainty weighs on growth. Markets should prepare for continued volatility as legal, political, and economic forces shape the ultimate trajectory of trade policy implementation.