Economists widely agree that easing trade tensions is important for sustaining U.S. economic growth. On May 12, U.S. trade officials announced a temporary reduction in tariffs with China, offering a brief reprieve in ongoing trade negotiations. While this adjustment lowers some tariffs, many remain significantly higher than past levels, including those seen since the 1930s. Additionally, the reduction is scheduled to expire on August 12th unless a more permanent agreement is reached.
Despite ongoing challenges, this temporary relief is a positive step. Both the U.S. and China recognize that the originally proposed 145% tariff—now reduced to 30%—would have severely restricted trade between the world’s two largest economies, posing risks to businesses and consumers alike. Experts believe that 90 days may not be enough time to finalize a lasting agreement, making an extension of the current negotiations likely. This pause in trade tensions has contributed to stock market stability and eased immediate concerns about a potential recession.
However, broader economic effects remain. Even before the announcement of possible tariff increases to the European Union, the U.S. effective tariff rate stood at roughly 15% versus less than 5% at the start of 2025 and the highest in nearly a century. Higher tariffs can contribute to inflation and slower growth, but for now, the economy appears resilient. While there are costs associated with elevated tariffs, the risk of an immediate recession has lessened unless shifting consumer sentiment leads to broader changes in spending behavior.
Growing Importance of Trade
The current effective tax rate is at its highest level since 1930, when the Smoot-Hawley Tariff Act raised tariffs above 20%, exacerbating the economic downturn. These protectionist measures led to a sharp decline in U.S. trade, reducing imports and exports by more than 60% over the following two years. However, while tariffs contributed to the Great Depression, other factors—such as the 1929 stock market crash, flawed monetary policy, and instability in the banking system—played a larger role in prolonging the crisis.
Although today’s tariffs are currently lower than those seen during that era, their impact could be more significant due to the greater global integration of the U.S. economy. Trade now accounts for a much larger share of GDP than in the past, and imports are essential to both consumer spending and business operations. For instance, imported goods make up most of the clothing, footwear, and durable goods purchases, including appliances and electronics. Consumers are starting to become anxious as sentiment, measured by the University of Michigan, has declined in the recent survey periods.
Businesses also rely heavily on imported components to maintain production, particularly in industries such as automotive manufacturing, where more than half of assembly parts are sourced abroad. Any disruption to supply chains, especially in the context of trade tensions, could affect the availability and cost of goods. This is further complicated by the widespread adoption of just-in-time inventory management, which depends on stable and predictable import flows.
The Economy is in Good Shape – For Now
The temporary rollback of the most significant tariffs is expected to support global trade, reducing concerns about supply shortages in the coming months. However, between the tariff increases on April 2 and the partial agreement on May 12, trade flows were disrupted, leading to lower port activity and wage reductions for some dockworkers and truckers. Despite these setbacks, neither broader economic activity nor inflation has shown noticeable negative effects from the tariffs or the temporary slowdown in trade.
Economic indicators continue to reflect stability, with strong job growth, limited layoffs, and steady consumer spending—the primary driver of growth. Furthermore, although concerns about tariff-induced inflation have been widely discussed, recent price data suggests inflation has remained stable or even declined through April.
However, the absence of immediate effects does not mean tariffs will have no impact. There is typically a delay between when tariffs take effect and when consumers experience price changes. Shipping times from China to the U.S. range from four to six weeks, and additional time is needed for unloading and distribution. Many of the goods currently being sold arrived before the latest tariffs were implemented, as companies preemptively stocked inventory to avoid cost increases. As these inventories decrease, new shipments carrying the higher tariff rates will begin arriving, potentially influencing prices in the weeks ahead.
Summer Blues
The inflationary effects of tariffs are expected to become more apparent this summer, depending on several influencing factors. Some of these effects could be mitigated if exporters lower prices or if the U.S. dollar strengthens, making imports more affordable. However, the dollar has depreciated by more than 7% against the currencies of major trading partners this year, potentially offsetting any price reductions from exporters.
Another factor affecting price increases is how businesses handle the additional costs. Some companies may choose to absorb a portion of the tariffs to maintain customer demand, though this would likely result in lower profit margins—an issue particularly concerning publicly traded firms. Smaller businesses, operating with tighter margins, may have fewer options and will likely pass tariff-related costs onto consumers. This challenge has contributed to declining small business confidence in recent months. Historically, businesses have passed about two-thirds of tariff costs onto consumers, and a similar trend is expected this time.
Higher prices could reduce discretionary income and weigh on consumer spending, particularly for lower-income households, which allocate a larger portion of their budgets to goods rather than services, the primary target of tariffs. Many households have depleted excess savings accumulated during the pandemic, and delinquency rates on debt have been increasing, suggesting greater financial strain. The potential for a silver bullet in the form of a sweeping tax bill may provide stimulus and immediate support, counteracting the general increase in prices.
The Fed’s Dilemma
While inflation has remained stable in recent months, it is expected to rise as tariff-related cost increases begin to affect consumer prices. Estimates suggest inflation may increase by approximately 1.0% by the summer. This adjustment is not unexpected, as consumers have anticipated higher prices and adjusted their purchasing behavior, accordingly, accelerating spending earlier in the year. This trend has contributed to strong economic performance in the first quarter.
However, as summer progresses, the Federal Reserve may face a familiar challenge: whether to lower interest rates to support a slowing economy or to raise them in response to rising inflation. At present, policymakers have adopted a cautious approach, waiting for clearer signs on how inflation and growth trends evolve before adjusting. A key question is whether the anticipated price increases from tariffs will be temporary or signal a return to sustained inflationary pressures. Fed Chair Jerome Powell, along with most economists, has suggested that the inflationary impact will likely be one-time, assuming tariffs do not rise further after the current pause ends.
Ultimately, the Fed’s decision will be guided by its dual mandate of maintaining maximum employment and price stability. Currently, inflation remains above its 2% target, while unemployment remains near historic lows at just over 4%. This balance has led the Fed to keep interest rates at elevated levels until clearer signs emerge of labor market weakness. While economic indicators continue to reflect strength, surveys suggest growing consumer concerns about potential job losses later in the year. These concerns, coupled with reduced disposable income due to tariffs, could dampen consumer spending and influence the Fed’s future policy direction.
Given the current fiscal environment, monetary policy will be the primary tool for managing economic stability. However, despite legitimate concerns about the rising fiscal deficit, Washington is pushing forward with a reformative and stimulative tax bill. It is quite possible that despite the tariffs, both monetary policy and fiscal policy could end up providing growth for the economy into the back half of the year. This broader economic backdrop will likely shape discussions as policymakers look ahead to 2026.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or connect@lptrust.com.
This newsletter is provided for informational purposes only.
It is not intended as legal, accounting, or financial planning advice.
