The escalating trade war between the U.S. and China could cause interest rate hikes, the very opposite of what President Donald Trump wants, some analysts have told CNBC.
Recent market consensus has suggested that the U.S. Federal Reserve is unlikely to raise interest rates, with Fed funds futures indicating a 76% chance the central bank will instead cut rates by 25 basis points before September. As of Wednesday, futures had also priced in a one-in-three chance that the Fed will cut twice by the end of the year.
Trump has regularly expressed his disapproval of high interest rates and called for the Fed to cut, tweeting Tuesday that the U.S. would win the trade war if the central bank followed his advice.
But some analysts are striking a contrarian tone. Mark Phelps, CIO of concentrated global equities at AllianceBernstein, told CNBC Wednesday that if prices are pushed up because of Trump’s tariffs on Chinese goods, the Fed may respond to the inflationary impact by hiking interest rates.
Central banks will generally raise rates when inflation is predicted to rise above their inflation target, and higher rates tend toward moderate economic growth. This increases the cost of borrowing and can therefore limit the growth in consumer spending.
“Tariffs go up, you’ll see some hit to margin for companies, and that probably reduces their investment — that’s not great for growth,” Phelps said.
He added that higher prices will reduce consumer purchases of goods, also reducing growth.
“There will be an inflationary impact so the Fed is going to have potentially growth slowing and inflation going up — not an ideal set of circumstances, but certainly not something where they’re going to rush out and just cut rates for the sake of it,” Phelps said.
This view was echoed by Giles Keating, senior advisor at Torchwood Capital, who told CNBC “Squawk Box Europe” that the bond markets were “gambling that when inflation does go up, the Fed will look through that and say ‘it’s just higher tariffs,’ that it’s a one-off and it will go away.”
Meanwhile Jinny Yan, chief China economist at ICBC Standard Bank, also told CNBC that while Trump would love to cut interest rates, “probably the opposite direction would be justified because inflationary pressures will hit the United States, therefore hiking the rates might be the thing to do.”
The Fed has indicated that it is not ready to move rates in either direction at this point, but market sentiment remains expectant of a cut by the end of the year.
Yardeni Research President Ed Yardeni said in a note Wednesday that it was “unlikely that the Fed would raise interest rates in response to what would be a one-shot boost to the inflation rate from higher-priced Chinese goods.”
Yardeni also doubted that higher prices would reduce the purchasing power of American consumers, since importers might absorb some of the increased cost of doing business with China, which would squeeze their profit margins instead of passing costs to consumers.
In response, Yardeni argued, some businesses might move their supply chain away from China to avoid the tariff burden, which may mean the Chinese yuan continues to fall and offsets some of the tariff cost.
Pigeons fly past the US Federal Reserve in Washington.
Nicholas Kamm | AFP | Getty Images