Inflation Monitor: Limited Tariff Passthrough So Far

Summary

• April CPI was below expectations but higher MoM than in March.
• There was limited pass through from tariffs to core goods. The uptrend in goods prices flattened.
• OER continued slowing.
• Supercore inflation continued its marked slowdown, largely driven by airlines choosing volume over margins and by wage disinflation facilitated by falling energy prices.
• CPI was stable YoY due to an increase in goods prices offsetting the slowdown in OER and supercore. CPI stability likely reflects a combination of implementation lags, intermediaries absorbing the tariffs and demand weaknesses.
• Market-based expectations have decreased ahead of survey-based expectations that remain elevated.

Market Implications

• The Trump administration’s deal with China has lowered recession risks and I therefore only expect two-three Fed cuts in 2025, against markets expecting two cuts.

Negative April CPI Surprise

Both headline and core CPI came in below consensus (Table 1). Sam’s model correctly predicted the print right up to the last bp!

MoM April CPI rebounded relative to March (Table 2). The rebound was driven by goods and supercore.

Limited Tariff Passthrough to Goods Inflation

April was the first month of significantly increased average effective tariffs (Chart 1). The 10% baseline tariff was applied to nearly all US imports. There were also tariffs on cars, and tariffs on most imports from China were increased to 145%.

We do not have April PPI and import prices yet but there was no obvious sign of passthrough to core consumer goods (Charts 2 and 3). This likely reflects a combination of exporters, importers, wholesalers and retailers ‘eating up’ the tariffs as well as implementation lags.

And while core goods inflation accelerated further YoY, the trajectory has flattened (Chart 4).

OER Inflation Continues Slowing

OER slowed MoM in April and remains on a downward trend (Chart 5). OER inflation remains above market rent inflation, suggesting further downside (Chart 6). When rents are rising, market rents rise faster than CPI rents (since the latter changes only when tenants move dwellings).

However, market rent indices are of recent vintage and may not fully reflect the state of the rental market. For instance, the Apartment List index has been showing rental deflation for the past two years, by contrast with Zillow that has been showing steady inflation.

Slower Supercore

Since end-2024, supercore has slowed dramatically (Chart 7). The slowdown reflects partly a sharp fall in airfares. In April 2025, airfares were 11% below their level of December 2024 (Chart 8). Meanwhile, TSA data shows passenger traffic has remained roughly unchanged relative to 2024 (Chart 9). This suggests airlines could be cutting fares to maintain sales volumes.

Wage disinflation is also weighing on supercore (Chart 10). In turn, wage disinflation has been supported by a slowdown in headline inflation that partly reflects energy deflation (Charts 11 and 12). This slowdown has allowed slower nominal wage growth and sustained real wage growth. Lower energy prices remain a key part of the administration’s economic strategy.

Stable April YoY CPI

April core CPI YoY was unchanged as faster core goods inflation offset the slowdown in supercore and OER inflation (Chart 13). Alternative CPI measures also show no or limited decline in April (Chart 14).

Core PCE decompositions show a lower contribution of demand-driven inflation but stable cyclical inflation (i.e., inflation sensitive to overall economic conditions, Charts 15 and 16).

Inflation Sweet Spot?

The limited passthrough from tariffs to goods prices reflect intermediaries ‘eating up’ the tariffs as well as implementation lags. It is also likely to reflect demand weaknesses that are limiting businesses’ pricing power.

Because of the chaotic tariff implementation, policy uncertainty has surged to level even higher than during the early stages of the pandemic (Chart 17). In turn, this has led to a collapse in business and consumer confidence (Chart 18).

This has yet to translate into hard data weakness largely because the latest NFP and GDP were collected before or near the tariffs’ implementation on 2 April. However, consensus expectations of zero increase in April retail sales suggest demand weaknesses are about to appear in hard economic data.

The limited passthrough could reflect a ‘sweet spot’ where most of the tariffs still must be implemented and demand weaknesses keep the impact of the limited implementation in check.

Will Survey-Based Expectations Follow Markets?

So far, long-term BEs have remained stable while short-term BEs have fallen to their level of January 2024 (Chart 19). By contrast, survey-based and forecasters’ expectations remain elevated (Charts 20 and 21). The disconnect between markets and survey-based expectations could reflect the former’s much higher frequency (daily) than the latter (monthly). Recent announcements of tariff pauses could see lower survey-based expectations.

Fed SEP core PCE forecasts have been stable and shown convergence to the 2% target over a two-year period (Chart 22). The next SEP is due at the 18 June FOMC. The Fed has repeatedly stated it expects the tariffs to delay the resumption of disinflation. This may not be so if demand weaknesses persist, energy prices continue falling, or more services providers join airlines in choosing demand volumes over margins.

Market Consequences

Inflation dynamics have been surprisingly subdued likely due to a combination of intermediaries ‘eating up’ the tariffs, implementation lags, and demand weaknesses caused by the extreme uncertainty created by the administration’s policies.

The recent pause on the 145% tariff on Chinese imports, a de facto embargo, lowers inflation and recession risks, the latter mainly through less downside to households’ real incomes. It does little to reduce policy uncertainty. This suggests demand weaknesses could persist, keeping inflation in check and seeing the Fed reconsider its hawkish wait-and-see stance.

I no longer expect the Fed to cut six times in 2025 due to lower recession risks but rather see two-three cuts against markets pricing two cuts.

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