Tariffs, Inflation, and the Fed’s Stagflation Dilemma

Written by Mark Scher, CIMA®

The debate over tariffs in the United States has taken on new urgency as inflationary pressures persist. Tariffs are, at their core, a tax on imports. When imposed, they raise the landed cost of goods entering the country, whether raw materials, intermediate components, or finished products. Those higher costs are typically passed along to US consumers and businesses, embedding upward pressure on prices. The inflationary impulse is particularly pronounced in sectors where imports dominate, electronics, autos, and certain consumer goods, because domestic substitutes are either limited or more expensive.

The impact does not stop at US shores. Trading partners often face retaliatory measures or weakened export demand. For economies that rely heavily on selling into the US market, tariffs act as a drag on growth. Producers abroad may attempt to absorb some costs to preserve market share, compressing margins. But over time, higher costs tend to filter back into local economies through reduced investment, lower wages, or increased domestic prices when supply chains are reconfigured. Thus, while US tariffs are inflationary at home, they can simultaneously be deflationary or even lead to stagflation abroad, reducing growth while raising price instability.

With the tariffs becoming broadly accepted, inflation will continue to erode the purchasing power of money while most likely leading to higher interest rates, which reduces demand for goods and services, which will ultimately lead to curbing inflation.  This is a self-inflicted supply shock by the current US administration.  Supply shocks tend to result in two bad outcomes, rising inflation and simultaneously, rising unemployment, which is a direct result of tariffs.

For the Federal Reserve, the challenge is acute. The Fed’s dual mandate, stable prices and maximum employment, becomes harder to balance when tariffs fuel cost-push inflation while also weighing on growth. If the central bank tightens policy to quell inflation, it risks deepening an economic slowdown. If it eases to support growth, it risks validating higher prices. This is the classic stagflation trap of the 1970s, now replayed in a modern globalised context.

Policymakers must weigh whether tariffs are a tool of strategic leverage or a blunt instrument that undermines monetary stability. For the Fed, the key question is whether to treat tariff-induced inflation as a transitory supply shock or as a structural force requiring prolonged restraint. With growth indicators softening and inflation stickier than hoped, the US is edging closer to a policy crossroads where every move carries significant trade-offs.

At MASECO, we believe in global portfolios.  From an academic standpoint, diversifying portfolios globally helps to avoid the home country’s bias trap.  There are two main types of risks in investing, they are systematic risk (market risk) and unsystematic risk (specific risk).  Systematic risk cannot be eliminated through diversification. However, by investing globally you could potentially reduce this market risk by being in as many investable countries as possible.  With unsystematic risk, being in a diversified portfolio absolutely helps reduce risk.
As global market capitalisation changes over time our portfolios adjust through our rebalancing exercise every six months.  This helps minimise risks associated with shifts in the global economy.

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