Impact of Tariffs on Inflation

Market analysts are closely watching how tariffs might affect consumer prices, especially as they review the US Consumer Price Index (CPI). It appears that tariffs from China could have a bigger impact than those in response from the US, particularly since trade talks seem to have stabilized. Research indicates that foreign exporters have been paying 14% of tariff costs, which could rise to 25%. US consumers have taken on 22% of these costs, and this could increase to 67%. Currently, US businesses absorb over half of the costs, but this might drop to less than 10%. Tariffs have raised core Personal Consumption Expenditures (PCE) price levels by 0.20%, with an extra 0.16% increase expected in July and another 0.5% from August to December. This could push core PCE inflation to 3.2% by December if underlying inflation stays at 2.4%. These inflation figures significantly influence the Federal Reserve’s outlook. Traders anticipate a rate cut in September. If inflation meets expectations, markets will likely remain stable. However, if inflation is lower than expected, discussions about the need for further rate cuts could intensify. Traders currently see an 89% chance of a rate cut in September, with about 57 basis points priced in by the end of the year. Analyst estimates for CPI vary, reflecting differing opinions on changes in core and headline inflation.

Impact on Markets and Strategies

We are keen to see if today’s inflation report reveals the impact of tariffs. The main focus is on core goods, as studies suggest consumers will soon bear a larger portion of these costs. This could push core inflation toward 3.2% by year’s end, which would pose challenges for the Federal Reserve. This comes after last week’s Producer Price Index (PPI) report for July 2025, showing a surprising 0.5% monthly increase, driven by rising costs for imported goods. This indicates that businesses are starting to pass along tariff costs to consumers. With traders almost certain of a rate cut in September, the biggest risk lies in unexpected inflation data. A higher-than-expected inflation number might lead the Fed to be less aggressive, causing a sharp drop in short-term bond futures. We observed a similar situation in late 2024 when the market reacted ahead of the Fed’s plans. Given this uncertainty, options strategies on interest rate futures look promising. A soft inflation number might lead to discussions of a 50-basis-point cut, while a hot number could rule that out completely. Buying volatility through straddles allows traders to benefit from significant market swings in either direction. We are also monitoring derivatives linked to consumer sectors. The National Retail Federation noted that consumer spending growth fell to just 0.1% in July 2025, indicating that household budgets may be strained. A high inflation figure would signal worsening margins for retailers, making puts on retail ETFs a potential safeguard. We can reference the trade disputes from 2018-2019 as a predictor of future outcomes. During that period, it took multiple quarters for tariffs to fully impact consumer prices, as businesses initially absorbed the costs. The current situation suggests we have moved beyond that absorption phase and are now in the direct pass-through stage. Create your live VT Markets account and start trading now.

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