Traders aren't taking Trump's tariff threats seriously. This Wall Street bank says they should.

MW Traders aren't taking Trump's tariff threats seriously. This Wall Street bank says they should.

By Vivien Lou Chen

Paris-based BNP Paribas expects 'permanent shock' to U.S. consumer prices from Trump 2.0 tariffs

One Wall Street firm is diverging from the pack by taking incoming President Donald Trump at his word on tariff proposals: It now sees the likelihood of a "permanent shock" to U.S. consumer prices and a need by the Federal Reserve to keep interest rates higher than otherwise would be the case.

Paris-based BNP Paribas (FR:BNP), one of two dozen primary dealers that act as trading counterparties to the Fed's regional bank in New York, said it is assuming Trump will implement "most if not all his campaign promises on foreign, economic and trade policy, including those that could harm the U.S. economy, such as import tariffs."

It added that "in this respect, our analysis diverges from what we perceive as the implicit market assumptions underlying current pricing."

To wit, stocks have soared to record highs during the past two weeks, with the Nasdaq Composite closing above 20,000 for the first time ever on Wednesday. Additionally, fed-funds futures traders are pricing in as many as four quarter-point Fed rate cuts through the end of next year following a widely expected reduction next week. Market-based gauges of future inflation, known as breakeven rates, over the next five, 10 and 30 years have also fallen from where they were on Nov. 6, a day after the election.

These moves are occurring as many market participants hold out hope that Trump's tough talk on tariffs turns out to be just a negotiating tactic.

The ramifications of taking Trump at his word are that a U.S. economy poised for a soft landing in early 2025 may end up stalling into 2026 as the incoming president's tariff and immigration policies take hold, outweighing his pro-growth initiatives, according to a 2025 Global Outlook report released by BNP on Thursday. The bank also expects market participants to begin pricing in higher U.S. inflation and fewer Fed rate cuts than they currently are.

"Some argue that Trump's policies (in particular tariffs), will not be inflationary on the basis that (i) he will not implement them, (ii) the dollarwill entirely offset the impact and (iii) there will not be any second-round effects. We think this framework is misguided," according to the BNP report. "We think Trump will implement - even if not in full - large swaths of his tariff threat."

BNP added: "We envisage a permanent shock to the level of consumer prices in the U.S. [around 2 percentage points], and a temporary impact - albeit throughout our two-year forecast horizon - on U.S. inflation. But we do not expect any unanchoring of inflation expectations. In other words, we assume that in maintaining restrictive policy for longer than would otherwise be the case, the U.S. Federal Reserve keeps long-term inflation expectations in check."

Here is a breakdown of how BNP is thinking about the year ahead:

-- Trump's anticipated tariffs could result in a direct lift to consumer prices of around 80 basis points on their own. "However, we see tariffs affecting inflation not only through rising prices for imported goods, but also via second-round effects on the general price level." BNP's model finds that increases in import prices transmit broadly to other goods, services and wages, and are amplified through short-term momentum.

-- The upper end of the Fed's main interest-rate target should remain at 4.5% for all of 2025, assuming the central bank delivers a 25-basis-point rate cut next week. The fed-funds rate target currently sits between 4.5% and 4.75%.

-- Two- BX:TMUBMUSD02Y, 10- BX:TMUBMUSD10Y and 30-year Treasury yields BX:TMUBMUSD30Y could respectively end 2025 at 4.55%, 4.65%, and 4.8% - levels higher than where they are likely to be in the first quarter of next year.

-- The dollar DXY has further upside potential against China's onshore renminbi USDCNY, the Mexican peso USDMXN and the Canadian dollar USDCAD. Trump has called for an additional 10% tariff on goods from China and a 25% tariff on Mexican and Canadian imports.

-- A stronger dollar and a Fed that remains on hold should keep a lid on gold prices GC00 into the second half of 2025 after the metal hits new highs in the early part of next year.

-- Bearish pressures are likely to develop on crude oil prices CL00 BRN00 in the second half of 2025, as tariffs take hold.

The past week has brought more indications that U.S. inflation is likely to be tougher to combat than many thought. Wednesday's consumer-price index for November showed the annual headline CPI rate edged back up to 2.7%, from 2.6% previously. And Thursday's overall producer-price index for November came in at a hotter-than-expected 0.4%, or double the median estimate of economists polled by the Wall Street Journal.

Two- through 30-year Treasury yields were slightly higher in Thursday afternoon trading after the producer-price data. Meanwhile, all three major stock indexes DJIA SPX COMP moved lower, with the Nasdaq Composite pulling back from Wednesday's record closing level of 20,034.89.

-Vivien Lou Chen

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December 12, 2024 13:42 ET (18:42 GMT)

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