Slowing Inflation Nears Fed's 2% Target, but Trade Wars May Spoil the Party

The cost of living in the United States saw minimal movement in April, offering some relief to consumers and policymakers alike. According to the Bureau of Economic Analysis, the personal consumption expenditures (PCE) index—commonly regarded as the Federal Reserve’s preferred inflation measure—edged up by only 0.1% in April. That modest gain comes after inflation remained flat in March, marking the softest two-month stretch for inflation since the COVID-19 pandemic began in 2020.

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On a year-over-year basis, inflation slowed to 2.1% in April, down from 2.3% in March. This puts inflation at its lowest annual rate since the early stages of the pandemic and matches the same level briefly reached in September last year. The Federal Reserve has long targeted a 2% annual inflation rate as a sign of economic stability, and this latest data suggests the central bank is finally getting close to that goal.

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However, whether this recent cooling trend in inflation will last is up for debate. A primary concern is the ongoing trade war, which has the potential to stoke consumer prices in the months ahead. Many economists and Federal Reserve officials have warned that the summer could bring renewed inflationary pressures, particularly as the costs associated with tariffs begin to impact supply chains and production costs more noticeably.

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Some potentially inflation-reducing developments have emerged, however. The Biden administration recently rolled back certain tariffs, and two federal court rulings this week concluded that the president lacked the authority to impose most of the duties under prior orders. These legal challenges could offer temporary relief, though any final resolution is expected to take months. In the meantime, the administration could pursue new strategies to reintroduce tariffs, keeping the outlook uncertain.

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Delving deeper into the data, core inflation—which excludes volatile food and energy prices—also rose by only 0.1% in April. This is another encouraging sign, as the core rate is closely monitored by the Fed for its reliability in predicting long-term inflation trends.

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The annual core inflation rate dropped to 2.5%, the lowest level since early 2021. That decline from March’s 2.6% figure suggests that broader price pressures are easing across various sectors of the economy.

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The PCE index, formally known as the personal consumption expenditures price index, carries significant weight with policymakers because of its comprehensive nature. Unlike the more widely known consumer price index (CPI), the PCE captures a broader set of consumer behaviors and tends to fluctuate less due to short-term price swings in necessities like food and fuel. That’s why the Fed places extra emphasis on the core PCE figure when crafting monetary policy.

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Despite the positive signals, the overall picture remains mixed. While inflation appears to be nearing the Fed's ideal level, the ongoing trade tensions between the U.S. and China are injecting a level of unpredictability into the economic outlook.

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Tariffs, which are paid by American importers, can lead to higher prices for consumers if companies pass along those costs, or they can squeeze corporate profits if companies choose to absorb the costs themselves. Either way, the outcome could disrupt the currently improving inflation environment.

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Economists are keeping a close watch on how the situation evolves. Ali Jaffery, an economist at CIBC Capital Markets, noted that under different circumstances—specifically, the absence of a trade war—April’s inflation report might have been seen as a clear victory. “If there wasn’t a trade war going on, we all might have been impressed by the resumption of inflation progress and the return of headline inflation to target,” Jaffery wrote in a client note.

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He added that the current uncertainty surrounding trade policy is likely to prompt the Federal Reserve to adopt a cautious approach. “Today’s data and the unpredictability of trade policy in Washington will reinforce the Fed’s desire to wait things out. Inflation enters the trade war in decent shape and the economy looks robust.”

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The markets responded to the mixed signals with slight hesitancy. The Dow Jones Industrial Average showed modest gains, while the S&P 500 slipped marginally. Investor sentiment was further shaken by President Trump’s accusations that China had violated existing trade agreements. Meanwhile, the yield on the benchmark 10-year Treasury note rose slightly to 4.4%, signaling lingering investor caution.

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In a related positive sign, consumer sentiment improved toward the end of May, partly due to a temporary easing of trade tensions between the U.S. and China. And with the U.S. trade deficit in goods shrinking sharply in April, some analysts believe that economic growth could accelerate in the second quarter.

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Still, the road ahead remains uncertain. With inflation showing signs of easing but trade policy still in flux, both the markets and policymakers will be closely watching for the next developments.

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