Trump’s "liberation day" reciprocal tariffs turned out to be much harsher than expected, stoking the possibility of an all-out trade war and a new inflationary pulse, but against this uncertain backdrop, Citi analysts continue to believe a softer labor market will sway the Federal Reserve to deliver five rate cuts this year.
Citi analysts believe the elevated tariffs will persist for at least the next few months, which is expected to raise inflation significantly. But a softening labor market will ultimately sway the Fed to lean dovish, Citi analysts said in a recent note.
"Ultimately, we expect officials to lean dovishly toward their employment mandate and deliver 125 basis points of rate cuts this year," the analysts said.
The Apr. 2 "Liberation Day" tariffs announced by the Trump administration brought the effective tariff rate from low single digits a few months ago to above 25%, far exceeding expectations.
While some have speculated that these tariffs would likely force trade partners into making a deal to alleviate trade pressure, Citi believes this bevvy of tariffs will likely stick around for a few months, pushing inflation much higher.
"Our base case, most of these tariffs will be sustained for at least the next few months," the analysts said. "That should be enough time to raise inflation and core inflation could now reach close to 4% by the end of the year."
The tariffs, however, provide Trump with political leverage, as the administration can point to approximately $700 billion in annualized revenue they would generate, assuming trade deficits remain unchanged.
The revenue would likely help smooth the path for fiscal expansion, with Treasury Secretary Bessent suggesting on Wednesday that they could be used to offset new individual tax cuts.