Mild Wage Growth Will Limit Inflationary Impact of Higher Tariffs
Tariff revenues may approach a tiny 1% of GDP …
Treasury Secretary Bessent claims the federal government will collect more than $300 billion in tariff revenues in 2025, or an amount that approximates just 1% of current-dollar GDP. The projected $300 billion of tariff revenues also approximate 4.2% of federal outlays and 15.0% of the federal budget deficit from the 12-months-ended May 2025.
May’s core import price index edged up by a mild 1.8% from a year ago …
Tariffs have yet to turn the US’ import price index significantly higher. Note that tariffs are included in the import price index.
For May 2025, the import price index barely rose by 0.2% from a year ago. The latter was well under the 1.2% average annual rate of import price inflation during the 12-months-ended April 2025.
After excluding the price deflation affecting petroleum products, May’s core import price index rose by a tolerable 1.8% year on year. Nevertheless, the latter was somewhat above its average annual increase of 1.6% during the 12-months ended April 2025.
The price index for imports from China fell by 2.1% year-on-year in May. May’s 1.1% yearly increase for the price index of imported autos trailed its 2.1% average annual increase of the 12-months ended April 2025.
Only one category showed a notable acceleration by US import price inflation. May’s 5.8% annual rate of price inflation for imports of industrial supplies and materials excluding petroleum was well above its 3.6% average annual increase for the 12-months ended April 2025.
Coincidentally, May's price index for US exports rose by 1.7% annually, which was faster than its 1.1% average annual increase of the 12 previous months.
Tariffs lift prices of copper, steel, and lumber …
Tariffs, both actual and prospective, have put upward pressure on the prices of copper, steel, and lumber.
In terms of recent moving 5-day averages, copper’s price was by 30.2% since the end of 2024 and higher by 15.3% from a year ago; steel's Midwest mill price was up by 25.4% since the end of 2024 and higher by 30.1% from a year ago; and the price of the most heavily traded lumber futures contract was up by 12.9% since the end of 2024 and higher by 37.0% from a year ago.
The record shows plenty of wide swings in the prices of copper, steel, and lumber. For example, the price of copper’s 4.4% average, annualized increase since January 1985 included year-to-year changes that ranged from a bottom of -48% and a top of +113%. The standard deviation of copper’s yearly percent price changes was 21.7 percentage points. Thus, there was a 67% confidence interval that the annual percent change for copper’s price would be between -17% and +26%.
For purposes of comparison, core PCE price inflation’s 2.4% annual average since 1984 was within a 67% confidence interval of +1.3% to +3.5%. It’s worth mentioning that potentially internationally tradeable consumer goods make up no more than 24% of the core CPI price index.
Price of crude oil matters more to core price inflation than do industrial metals prices …
In stark contrast to the recent prices of steel, copper, and lumber, the latest moving 5-day average for the price of West Texas Intermediate (WTI) crude oil was off by -3.9% for 2025-to-date and down by -17.7% year-on-year.
And the latter is important given how the annual rate of core PCE price index inflation shows a much stronger correlation of 0.42 with WTI crude oil’s annual rate of inflation compared to core inflation’s correlations of 0.20 with the yearly percent change of a base metals price index and 0.18 with the annual rate of copper price inflation.
Moreover, the record shows that not even the rapid growth of most industrial material prices, including crude oil, assures an elevated pace for core PCE price index inflation. For example, core PCE price index inflation averaged 1.7% during the two-years-ended July 2017 notwithstanding average annual rates of growth of 26.1% for the price of WTI crude oil and 14.5% for the base metals price index. Among other prices, the latter included average annual rates of price inflation of 20.5% for steel and 12.5% for copper.
Core PCE price index inflation’s strongest correlation is with wage inflation …
What mattered more at limiting core inflation’s growth rate during the two-years-ended July 2017 were the average annualized growth rates of 2.7% for average hourly earnings and 5.0% for total wage & salary income. In terms of yearly growth rates, the core PCE price index showed correlation coefficients of 0.63 with the average hourly wage and 0.60 with wage & salary income, where both were well above the core PCE price index’s earlier cited correlations with the price of crude oil, the base metals price index, and the price of copper.
In summary, unless wage inflation accelerates and, thereby, makes higher consumer prices affordable, any tariff-induced price hikes will be short-lived. Consumers may respond by curtailing outlays on products subject to tariff-induced price hikes. Tariffs may eventually do more to slow economic growth than to stoke a recurring rise by consumer price inflation.
Financial markets shrug off latest tariff news …
It’s hard to accept forecasts of an impending recession, if holders of risky high-yield corporate bonds are willing to accept historically low compensation for default risk.
On balance, financial markets have been indifferent to the latest episode of Trump’s Tariffs. After rising by A during 2025 second quarter, the S&P 500 has gained 1.2% thus far in the third quarter. The VIX recently closed at 15.8 points for its lowest daily finish since mid-February 2025. The VIX is again under its long-term median of 16.8 points.
In contrast, a composite high-yield bond spread’s month-long average has been under its comparably measured median of 434 basis points (bp) since October 2023’s 450 bp.
The fear of tariffs lifted the VIX’s month-long average up from December 2024’s 15.9 points to April 2025’s 32.0 points, where the latter was the highest month-long average since the COVID-inspired 42.0 points of April 2020. To the contrary, the high-yield bond spread’s month-long average underwent a relatively milder upturn from December 2024’s 288 bp to April 2025’s still below median 405 bp.
Housing-related shares lead US equities thus far in the third quarter …
Since the end of June 2025, the S&P 500’s homebuilders stock price index is up by 6.9% and the PHLX’s index of housing sector share prices has gained 6.0%. Both were well above the comparably measured increases of 1.2% for the S&P 500 and 1.3% for the NASDAQ.
Expectations of an eventually less-than-4% 10-year Treasury yield may help to explain the improved performance of housing-related shares.
As of July 10, the FHLMC’s 30-year mortgage yield was at 6.72%. The fact that the now roughly 235 basis points (bp) spread between the 30-year mortgage yield and its benchmark 10-year Treasury yield is well above its 170 bp average reflects mortgage market expectations of an eventual return of a less than 4% 10-year Treasury yield that will prompt a wave of mortgage refinancings at a rate well under today’s 6.72%.
Mortgage lenders strongly believe that they will not receive an annual return of 6.72% indefinitely from the now 6.72% yield of a 30-year mortgage.