Why U.S. Inflation Underperformed Expectations Despite Tariffs? Will Inflation Resurge in the Second Half of 2025?
Review: Why U.S. Inflation Has Been Weak in the First Half of 2025
Despite the tariff impact, U.S. market inflation expectations, consumer inflation expectations, and import prices have risen, yet the CPI has remained weaker than expected. Since the implementation of Trump’s Tariff 2.0, market and consumer inflation expectations have surged. The University of Michigan’s one-year inflation expectations briefly spiked to 6.6%, and since April 11 (following the escalation of China-U.S. tariffs), the 10-year U.S. Treasury inflation expectations have risen by 13 basis points. Similarly, the tariff impact on inflation transmission—the import price index—saw a significant increase in April and May, with month-on-month rises of 0.5% and 0.4%, respectively, compared to a 0% increase earlier in the year. However, U.S. CPI inflation has consistently underperformed market expectations, with May CPI rising by only 0.1%, below the 0.2% expected.
Breakdown: Factors Behind Weak U.S. Inflation
- Energy Prices Weakened in the First Five Months of 2025, But Rebounded in June
From late 2024 to May 2025, U.S. WTI oil prices dropped by about $11 per barrel, weakening overall U.S. energy inflation. This decline also indirectly affected core inflation, particularly in transportation services and non-durable goods (such as clothing). However, as geopolitical factors led to a sharp rise in global oil prices in June, energy inflation may experience another uptick. - Service Inflation: Stabilizing Rent and Super Core Service Inflation
U.S. rent inflation, which accounts for one-third of the CPI, has lagged behind housing prices and new rental contracts, both of which point to a sustained cooling in rent inflation. Additionally, core non-rent service inflation in the first half of 2025 showed a clear weakness, reflecting a steady cooling in the U.S. labor market. Despite the unemployment rate remaining stable at 4.2%, non-farm job growth and average hourly wage increases have slowed from late last year. This, coupled with the economic impact of tariffs, has likely contributed to the cooling of service inflation. - Tariffs Have Had an Effect on U.S. Goods Inflation, but the Impact Was Weaker Than Expected
U.S. energy and service inflation were major contributors to inflation weakness, but these could be anticipated in advance. The real surprise came from goods inflation, where the impact of Tariff 2.0 was visible as early as March, but the effect on inflation was weaker than expected.
Deconstructing Why the Tariff Transmission to Goods Inflation Is Weaker Than Expected
The main reason U.S. inflation has been weaker than expected lies in insufficient tariff transmission. There are four major mechanisms impeding the transmission of tariffs to U.S. inflation: the delayed implementation of tariffs, “stockpiling” of imports, changes in the country-of-origin import structure, and businesses absorbing costs through profit margins. The first two factors are primarily “temporary” in nature.
- Slow Tariff Implementation Progress
One reason for the slow rise in U.S. inflation is the slow pace of tariff collection. In April, U.S. tariff revenue amounted to $15.6 billion, with imports totaling $276 billion. The actual tariff rate increased from 2.4% in March to 5.7% in April. After the tariff downgrade on May 12, the theoretical average tariff rate should range between 14% and 16%, but the actual rate remains lower than this, likely due to delays in the tariff collection process. For example, goods that were shipped before April 5, when the tariffs officially came into effect, were not subject to tariffs when arriving in the U.S. - “Stockpiling” Imports to Delay Price Increases
U.S. businesses have responded to tariff risks by accelerating imports, with the year-on-year growth rate of imports reaching 31.4% by March 2025. Over the eight months from July 2024 to April 2025, the excess import volume was 0.9 to 1.4 times the monthly Personal Consumption Expenditures (PCE) of imported goods. U.S. businesses rely on stockpiling “cheap” inventory and “rushing imports” to delay price hikes by about 3 months. - Shifting Import Sources to Reduce Tariff Impact
From November 2024 to April 2025, the share of U.S. imports from China decreased from 13.8% to 9.2%, reflecting the effects of “re-exporting” through emerging economies and transit through countries like Mexico. Since the U.S. imposes higher tariffs on Chinese goods compared to other countries, the shift in the import structure has alleviated the impact of tariffs on U.S. businesses. - Absorption of Costs by U.S. Businesses
U.S. businesses have been absorbing some of the tariff costs, but surveys show that businesses are still willing to pass on a portion of the costs to consumers. During the period of Tariff 1.0, academic research indicated that U.S. retailers absorbed most of the tariff cost pressure without passing it on to consumers. In the case of Tariff 2.0, Trump also called for retailers to absorb the tariff costs. According to Peterson Institute for International Economics (PIIE) estimates, the current tariff rate is expected to reduce U.S. retail profit margins by about 2.5 percentage points, which is much lower than the 31.3% gross margin for U.S. retailers (in 2022) but relatively close to their operating profit margin of around 5% (Q1 2025).
Future U.S. Inflation Trend
U.S. goods inflation might be “delayed” but is unlikely to be “absent.” The delayed tariff collection, along with businesses “stockpiling imports,” have temporarily hindered the transmission of tariffs to inflation. Looking ahead to the second half of 2025, multiple indicators suggest that U.S. inflation may gradually rise. Retail prices in the U.S. have shown signs of accelerating since June, and various Federal Reserve surveys of manufacturing price indices point to growing upward pressure on goods inflation. Additionally, according to a New York Federal Reserve survey, most U.S. businesses indicated they would raise prices 1-3 months after tariff cost pressures became apparent.
Alaric expects that the peak of U.S. CPI inflation will occur in the fourth quarter of 2025, with a return to decline in 2026. Given the relative stability of inflation expectations in both the U.S. enterprise sector and market, the inflationary effects of tariffs may be “temporary.” The impact of tariffs on inflation is expected to last for 2-4 quarters, and the peak of this inflationary rebound could occur between the fourth quarter of 2025 and the second quarter of 2026. Alaric predicts that the core PCE inflation peak will occur in Q4 2025 (core PCE inflation at 3.3%, PCE inflation at 3.1%), representing a near 1 percentage point rebound.
In the current uncertain economic and political environment, some factors may cause inflation to deviate from predictions. Inflation Upward Risks: If the U.S. dollar continues to depreciate, tariffs escalate, or oil prices rise, U.S. inflation may exceed expectations, with a low base in the third quarter helping CPI year-on-year growth and a more “hawkish” Federal Reserve. Inflation Downward Risks: If the U.S. economy weakens unexpectedly in the second half of the year, such as a sharp rise in the unemployment rate, the pressure from economic slowdown could cause U.S. inflation to underperform expectations, leading to a more “dovish” Federal Reserve.