Increased US scrutiny of imports from China amid cooling trade relations between the two countries threatens to tip the scales in the Federal Reserve's battle against inflation.
US President Joe Biden's announcement of higher tariffs on Chinese exports of advanced technology products, including electric vehicles and solar components, follows a string of duties levied against Chinese exports by Biden's predecessor. It comes amid strained US-China trade relations and ahead of a domestic election day rematch between Biden and former president Donald Trump that is increasingly putting the two candidates in competition over protectionist trade policies.
Yet economists say the new duties, and tariffs more broadly, may carry an unwelcome consequence: higher prices and a heightened probability of higher-for-longer interest rates. While the Fed is expected to slightly lower benchmark rates this year from their current decades-long high, higher tariffs are likely to feed through to higher prices, complicating central bankers' decisions.
"In the short run, tariffs are inflationary," said Ben Herzon, senior US economist at S&P Global Market Intelligence. "An imposition of new tariffs aimed at mainland China likely would delay or slow Federal Reserve rate cuts, keeping interest rates higher for longer and weakening the near-term real GDP outlook."
Protect
Amid recent US and EU efforts to reshore certain critical supply chains, the International Monetary Fund warned against the institution of protectionist measures in its April World Economic Outlook report, saying they could "trigger retaliation from trading partners" and "generate welfare losses."
The industries that have so far been tariff targets represent a small percentage of total US imports from China. Of the 14 categories of goods proposed to see increased tariffs between 2024 and 2026, imports of the top five highest-value categories — lithium-ion batteries, aluminum, semiconductors, iron and steel, and permanent magnets — accounted for approximately 3% of the $575.69 billion in US imports from China in 2022, according to UN Comtrade data.
Measured in dollar value, the US has only imported 2% less from the major Asian economy in the first quarter of 2024 compared to the first quarter of 2023, according to US Census Bureau data.
The impact of the most prohibitive tariff — 100% on EVs — would likely be modest given the relatively small US market size, said Steven Cochrane, chief Asia-Pacific economist at Moody's Analytics.
"The new additional tariffs are not being placed directly on the vast array of consumer goods that are imported from China," said Cochrane. "Available domestically-made EVs will likely continue to be priced as they are currently, or they will come down slowly as technology and production processes improve. But the pressure to reduce prices quickly to approach those offered on China-made autos is eased."
Inflationary effect
Although tariffs can have the long-term impact of better economic growth in the domestic economy, near-term effects would run counter to the Fed's plans.
"Protectionism is a market distortion in the direction of keeping up prices in certain sectors of the economy. Any distortion of that nature is going to have an impact on inflation," said Graciela Chichilnisky, economics professor at Columbia University in an interview.
US GDP is expected to grow by 2.49% in 2024, according to Market Intelligence data, slightly below the 2.54% growth achieved in 2023.
Steeper US tariffs would have a negative effect on both US and global GDP figures by way of greater inefficiencies, said Herzon with Market Intelligence.
"Global supply chains have developed to how they are today to take advantage of efficiencies in production. This keeps world and US GDP higher and prices lower than would exist without globalization and trade," Herzon said.
The Fed has kept the benchmark federal funds rate at a range of 5.25-5.5% since July 2023 as policymakers aim to bring inflation to 2% annual growth. The consumer price index hit 3.4% in April, a slight acceleration from earlier in the year but drastically lower than the peak of 9.1% in June 2022.
Resilience in the labor market and among US consumers have contributed to the Fed's higher-for-longer approach to interest rates, though the Fed's latest economic projections in March suggested three 25-basis-point rate cuts before year-end.
Fed Chairman Jerome Powell this month signaled rates may need to stay higher for longer as inflation has yet to cool to target levels. Fresh Fed projections are due in June, and market watchers have narrowed their expectations to one-to-two cuts by the end of the year, according to the CME FedWatch Tool, which tracks investor sentiment through federal funds futures.
"On the whole, if you are really concerned about inflation, then you may want to steer away from anything that can balance things in that direction, and [protectionism] is certainly one of them," Chichilnisky with Columbia said.