Macro & Strategy - September 2025

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You can’t always get what you want

Section 1: Inflation is coming to the U.S. (whether you want it or not)

As we enter the final stretch of 2025, the reality of a world where the United States imposes retaliatory tariffs on even its closest trading partners is sinking in.

Here’s the score: After starting the year with an effective import tariff rate averaging about 2%, the U.S. has seen a dramatic escalation in trade barriers, with the effective rate now in excess of 10% and most likely heading to a seemingly permanent 15- 20% —a level not seen since the 1930s.

Although the stated intent may be to stimulate growth and rebalance trade relationships, the nearterm consequences are beginning to show higher input costs, rising inflationary pressures, and growing fragmentation across supply chains.

Many investors remain hopeful that the impact of the highest tariffs the U.S. has seen in generations will be contained. Some pundits and policymakers have argued that tariffs will cause only a one-off increase in prices, and as such their impact on inflation will be transitory. Others even think the impact will be deflationary in the long term, as tariffs slow economic growth and eventually lead to lower prices across the economy.

Highlights

• Rising U.S. tariffs are creating a structural supplyside inflation shock, challenging the market’s assumption of a return to a Goldilocks regime and signaling persistent price pressures.
• Despite near-term support from expected Fed rate cuts, markets are underpricing the risks of weakened Fed independence, which could lead to higher long-term yields, dollar depreciation, and increased volatility.
• We maintain a slight overweight in equities— especially in Europe and Asia—while staying underweight in global fixed income and favoring currencies like the yen and high-yielding EM FX, given macro and policy dynamics.

But in our opinion such views are wishful thinking. Tariffs tend to act as a tax on consumption and production, and their disruptive effect will unfold over time. In economic parlance, tariffs, and rising protectionism more generally, represent a negative supply shock. History and theory tell us that such a shock leads simultaneously to higher prices and lower production. From a strategic standpoint, we recommend taking the long view: The economic costs are likely to be real, and the policy path ahead may be more complex than markets expect.

The internal workings of tariffs

The inflationary impact of tariffs is often underestimated because it’s not immediate; it’s cumulative.

Initially, firms absorb the cost increases through margins or inventory buffers. But as the buffers are depleted, cost pressures begin to surface. We’re entering that phase.

To understand how tariffs affect the economic picture, it’s useful to start from the ground up.

First, the obvious. Tariffs are a form of taxation, and the money collected by the government has to come from somewhere. In this case, it comes directly from importers’ bank accounts. In July, monthly U.S. gross customs duties clocked in at slightly more than $28 billion, up from $8 billion in February 2025. In other words, Corporate America is sending Uncle Sam a supplemental monthly cheque of $20 billion, which it needs to make up for by cutting its margins or by raising its prices, or, more likely, a combination of the two. One of the selling points of Trump’s trade policy was that global exporters would be the ones picking up the tab, by cutting their prices to keep their market shares in the world’s largest consumer market. Well, the data suggest that this isn’t happening yet.

The Bureau of Labor Statistics publishes data on the price index of U.S. imports, with the useful characteristic of stripping from it any customs duties and taxes, leaving only the price paid by U.S. importers of goods and services. As the chart above shows, the cost of imports before any duties and taxes has been steady over the past 18 months, showing no price concession from foreign exporters.

When you factor in an estimate of the change in import prices and account for taxes and duties, importers are de facto paying the bill, with a 7% bounce in the cost of imports. The effective tariff rate is 10% and is most likely heading to 15-20% in the coming months, so we should see the impact accelerate in the next two or three months, and the trickle-down effect on the CPI probably won’t be far behind.

The lagged effect of tariffs is showing up in producer prices, which have jumped by the most in a month since the inflationary period of 2021 and 2022. The next logical step is for this increase to bleed into consumer inflation over the next two quarters.

What is more important for investors and policymakers, this inflation isn’t just transitory; it’s structural. Tariffs disrupt supply chains, reduce competitive pressure (opening the door for U.S. firms competing with global suppliers to raise their own prices), and incentivize domestic substitution, all of which tend to raise prices over time.

Reminder: Inflation tends to be sticky

Markets have spent most of 2025 pricing in a return to the Goldilocks regime: moderate growth, falling inflation, and a dovish Federal Reserve. But the macro backdrop is shifting, and the path forward looks far less smooth than the consensus suggests. Although headline inflation remains contained, core goods inflation is reaccelerating, and the passthrough effects are beginning to show up in earnings calls and business surveys.

This matters because inflation is, by nature, sticky.

Once embedded, it tends to persist, especially when driven by supply-side constraints rather than overheating demand. When we dissect inflation, it’s useful to split the CPI into its sticky and flexible components—a distinction made clear by the Atlanta Fed’s analysis.

The sticky slice of core CPI, dominated by services, remains elevated compared with prepandemic norms and has picked up momentum in recent months.

This trend is particularly notable because it sits atop mounting pressures from goods affected by tariffs, reinforcing the case for persistent inflation.

On a final note, the impacts of tariffs could also manifest themselves in other ways that don’t show up in CPI prints. As producers adjust to rising input costs, they could start deploying tactics such as shrinkflation (less product in the same package), skimpflation (cheaper materials and lower build quality), and ghostflation (the silent disappearance of foreign goods from shelves as suppliers exit the U.S. market).

The result is a stealth erosion of economic quality of life: Consumers pay more, but get less—less quantity, less quality, and fewer choices. This degradation isn’t just economic; it’s psychological. It chips away at confidence, satisfaction, and perceived prosperity. In that sense, tariffs are inflationary not just in price terms, but also in lived experience.

The market’s reaction has been muted, most likely because headline inflation remains contained for now, and the Fed has not yet sounded the alarm. But this calm is precisely what makes the situation risky. The longer inflationary pressures build beneath the surface, the more abrupt the adjustment could be once they break through.

Section 2 – The Fed: Trump may not get what he wants in the end

As price pressure from tariffs works its way through the U.S. economy, the bigger story may be the unprecedented ways in which the Trump administration is pressuring the Fed to lower rates. The market appears to be taking it in stride: Futures are pricing in more than 100 basis points of rate cuts in the next 12 months, and the “policy relief” narrative is supporting all-time highs in equity markets.

But when we look at the macro fundamentals, the case for easing is far from compelling. In fact, it’s hard to justify any cuts at all according to the workhorse model known as the Taylor rule.

At its core, the Taylor rule is a simple yet powerful formula that helps central banks set interest rates on the basis of a few key variables: the deviation of inflation from its target; the distance between the unemployment rate and its long-term equilibrium level; and the gap between actual and potential GDP. Think of it as a GPS for monetary policy. If inflation is running hot or the economy is overheating, the rule suggests raising rates; if growth is weak and inflation is below target, it points toward easing.

The beauty of the Taylor rule lies in its balance: It anchors policy to economic fundamentals while allowing room for discretion. It doesn’t dictate decisions but offers a benchmark—one that often reveals when policy is too loose or too tight. During parts of the 2000s, for instance, the Fed kept rates well below what the rule prescribed, a move many argue contributed to the housing bubble. Today, with inflation still above target and growth moderating, the Taylor rule remains a useful lens to assess whether central banks are leaning too dovish or too hawkish.

Applying the model to the U.S. economy, we find that the current policy rate is, at best, precisely aligned with the model’s prescription. At worst, rates might even be too low!

Let’s start with the basics. Nominal GDP in the U.S. is expected to remain in the 4.5–5% range over the next few years. That’s not just healthy; it’s robust. Meanwhile, unemployment is hovering near 4%, close to most estimates of the non-accelerating inflation rate of unemployment (NAIRU). In other words, the economy is operating near full capacity. Headline inflation is also running at 2.7%, above the target level of 2%. This environment isn’t the kind that calls for monetary stimulus.

Yet markets are pricing in four cuts by mid-2026. Why? Because monetary policy is increasingly likely to become subservient to politics, and markets are adjusting to this reality. The Trump-Bessent administration has made no secret of its desire for lower rates, and the pressure on the Fed is mounting.

At first, the pressure seemed to be concentrated on Fed Chair Jerome Powell. But recently the administration has broadened its approach by targeting the Fed’s board of governors and publicly pondering whether it should get involved in the appointment of the Fed’s regional presidents.

President Trump isn’t even trying to hide his intentions. Case in point, this pronouncement made in the Oval Office on August 26: “We’ll have a majority very shortly. Once we have a majority, housing is gonna swing and it’s gonna be great.”

So far, the aggressive approach seems to be working for the White House: Governor Adriana Kugler resigned on August 1, a few months before the end of her term, and is being replaced by Stephen Miran, a Trump loyalist.

In a shocking development, President Trump is now attempting to fire another board member, Lisa Cook, on charges of mortgage fraud. It’s too early to know if the firing will hold up in the courts, but damage to the Fed’s independence is already taking shape. The next few months will see the Fed’s credibility, and long history of being (mostly) independent from political pressure, truly tested. As Powell nears the end of his term, he has so far continued to emphasize data dependence, patience, and the need to balance both sides of the Fed’s dual mandate.

But Powell’s term ends in May 2026, and his replacement will be a Trump appointee who will most likely be committed to lowering rates and running the economy hot, as desired by the White House. Meanwhile the Fed’s board of governors will probably be increasingly politicized, de facto causing a “Trumpification” of the Fed. Moreover, the process to select all 12 of the Fed’s regional presidents, who will serve new five-year terms starting in February 2026, could also fall into the grip of politics. As history showed in the 1960s and 1970s, what happens next will have far-reaching implications for main street and Wall Street alike.

Why Fed independence matters

The historical episodes involving Presidents Johnson and Nixon offer more than just political drama: They reveal the high stakes of central bank independence. When the Federal Reserve bends to political pressure, the consequences can be severe: Inflation surges, credibility erodes, and the economy pays the price.

An independent Fed, in contrast, can focus on longterm stability rather than short-term popularity. It can raise rates when needed, even if it’s politically inconvenient, to prevent overheating and anchor inflation expectations. As the Johnson-Martin episode shows, resisting pressure is hard, but giving in can be far costlier. We have a strong conviction that, as with any central bank, credibility is the Fed’s most valuable asset.

When markets believe the Fed will do what it takes to keep inflation low, expectations stay anchored— and that alone helps stabilize prices. But once political interference creeps in, as it did under Nixon and Burns, confidence unravels.

Inflation expectations rise, and the Fed’s ability to guide the economy weakens. Rebuilding that trust isn’t easy. It took Paul Volcker’s painful rate hikes in the early 1980s to restore the Fed’s reputation, proving that independence isn’t just a governance ideal, but a functional necessity.

Political cycles are inherently short-term. Elected officials often seek economic boosts ahead of elections, pushing for rate cuts or looser policy to create a temporary feel-good effect. But monetary policy operates on longer lags and deeper consequences. The Fed’s structure—long terms for governors and limited presidential influence—is designed to insulate it from such pressures.

Political pressure and the Fed: Lessons from Johnson and Nixon

Johnson versus Martin (1965)

In late 1965, Fed Chair William McChesney Martin raised rates to cool an overheating economy. President Lyndon Johnson, fearing the impact on his Great Society and Vietnam War financing, summoned Martin to his Texas ranch for a heated confrontation. Martin stood his ground, citing the Fed’s mandate. But over time he admitted to softening policy under pressure “to my everlasting shame.” Inflation, which had averaged 1.5% for over a decade, surged past 5% by 1969. The seeds of the 1970s Great Inflation were sown not by data, but by politics.

Martin’s initial resolve showed the value of independence; his later regret revealed how hard it is to resist sustained political demands.

Nixon versus Burns (1971–74)

President Richard Nixon wanted a booming economy heading into the 1972 election. He leaned heavily on Fed Chair Arthur Burns to deliver it. Burns obliged: Rates fell, money growth surged, and Nixon won in a landslide. But the aftermath was brutal. Inflation jumped from 3% to over 12% by 1974, when wage-price controls were lifted amid external shocks. Burns’ credibility eroded, and the Fed’s reputation took a hit.

It wasn’t until Paul Volcker’s 19% interest rates in 1979–80 that inflation was finally tamed, but at the cost of a deep recession.

Takeaway

Short-term political gains can lead to long-term economic pain. These episodes underscore why central bank independence isn’t just a principle; it’s a safeguard. When the Fed bends to politics, inflation expectations become unanchored, credibility erodes, and the cost of restoring stability multiplies.

Since the 1980s, when Fed independence became more entrenched, inflation has been lower and expansions longer. That’s not luck; it’s the dividend of keeping politics out of rate decisions.

In the end, the ability to say “no” to powerful politicians is what allows the Fed to say “yes” to price stability and sustainable growth. History makes the case clear: Independence isn’t a luxury; it’s a cornerstone of sound economic stewardship.

Our take

The Fed’s institutional memory is long, and the scars of the 1970s, when political interference led to runaway inflation, are still fresh. Moreover, the data simply don’t support a pivot. Core inflation, although off its peak, remains sticky. Wage growth is firm. And the tariff-driven supply shock discussed in Section 1 is likely to add upward pressure on prices in the coming quarters.

Cutting rates aggressively in this environment would be a mistake. It could stave off some of the tariffs’ negative impact on economic activity but would risk reigniting runaway inflation, undermining the Fed’s credibility and forcing a more aggressive tightening cycle down the road. It would also send the wrong signal to markets, namely that political pressure can override macro fundamentals.

Moreover, President Trump’s comments that easy monetary policy will lead to a housing boom might be ill advised, because a likely consequence of a tooaccommodating Fed would be to raise both the term premium and inflation expectations, thus pushing long-term rates meaningfully higher. As U.S. mortgages in the U.S. are generally of the 30-year, fixed variety, the outcome might well be even less accessible housing.

It doesn’t end there. Among other obvious negative economic consequences are a much weaker U.S. dollar on a lack of credibility from the Fed, leading to a loss of household purchasing power (through higher import prices) and a loss of attractiveness for foreign investments in the U.S. on a negative secular view on the greenback.

A September cut is now almost guaranteed after Powell’s Jackson Hole speech in late August. We’ll reserve our judgment as to whether this pivot is politically driven or truly reflective of the Fed’s framework. And, because rate cuts rarely come alone, one or two further cuts are now likely before the end of 2025. But the road beyond late 2025 has become wide open for any kind of scenario, and markets have yet to make up their mind on a direction.

Our view is that we need to raise the odds of a loss of Fed independence, leading to the following highconviction calls:

Short term (0–6 months)

• Higher volatility: Expect increased volatility in equities, Treasuries, and foreign exchange markets as legal uncertainty unfolds.
• Risk-on for equities: Rate cuts, or the expectations of more rate cuts, should benefit equities initially, especially those highly leveraged to interest rates.
• Safe-haven flows: Gold, the Swiss franc, and high-grade sovereign bonds may benefit from flight-to-safety behaviour.

Medium term (6–18 months)

• Yield curve steepening: If the Fed’s independence is compromised, long-term yields may rise on inflation fears and credibility loss.
• Dollar weakness: Political interference could further weaken the dollar, especially if foreign investors lose trust in U.S. monetary policy.

Long term (18+ months)

• Diversification imperative: Investors may shift toward global assets, especially in jurisdictions with stronger central bank independence (for example, ECB, BoJ, and BoC).
• Inflation hedging: Increased allocation to real assets (commodities, infrastructure, and inflationlinked bonds) may be prudent.

Bottom line

For investors, the takeaway is clear: Despite emerging inflationary pressures, expect a Fed that will be more dovish and aligned with the Trump administration’s priorities.

The first-order effect is likely to be higher nominal growth, with rate cuts stimulating consumption and investment. At the same time, inflationary pressures should be reinforced, as supply-side inflation from tariffs meets demand-side stimulus. Bubble risks are also rising, but whether it will be in equities, real assets or some other speculative assets is still up in the air.

Our knee-jerk reaction to this soap opera is that easy money tends to benefit equities and other risk assets, at least initially. But there will also be more adverse consequences, because we think markets are not properly priced for what appears to be a significant rupture in Fed independence. Long bonds are vulnerable to higher inflation and rising term premiums. And the dollar, already under pressure since the beginning of the year, should continue to retreat, given that the Fed’s commitment to stable inflation is one of the key pillars of its role as the global reserve currency.

Investors should also remember that running the economy hot leads to boom-bust cycles. And although a boom can last a while, the subsequent bust could tarnish the legacy of this administration, and Trumpism at large.

The bottom line? Trump ultimately may not get everything he wants. He might get lower policy rates and a hot economy, but history suggests there will be a price to pay.

Positioning

We are maintaining a slightly overweight position in equities, with a particular emphasis on European and Asian markets. Improving economic conditions— especially in Europe, where recent indicators of manufacturing activity have surprised to the upside despite ongoing trade tensions with the U.S.—are reinforcing our constructive view. Valuations outside the U.S. remain compelling.

Although elevated multiples in the U.S. are often justified by the dominance of fast-growing AI-related sectors, we note that even non-AI U.S. equities continue to trade at a sizeable premium relative to global peers.

In our view, this valuation gap is not fully warranted, given the current macro backdrop, and is likely to compress over time. Fiscal expansion in Europe is also expected to benefit old-economy sectors, such as industrials and financials. The year-to-date outperformance of equity markets such as Spain’s or Italy’s is testament to this dynamic whereby markets with very little or no tech exposure are still managing to outperform the AI-heavy S&P 500. As such, we see an opportunity to increase exposure to regions where fundamentals are improving and valuations offer more attractive entry points.

We are maintaining an underweight in global fixed income. Although the likelihood of adjustment rate cuts by the Federal Reserve has increased recently as a result of a weakening in the labour market, we think the inflationary implications of trade tariffs could steepen the yield curve, limiting the upside for longer-duration bonds. In our view, this dynamic challenges the conventional assumption that duration will benefit meaningfully from policy easing—or at least relative to equities. At the same time, fiscal pressures remain elevated, particularly in the U.S., where persistent deficits continue to drive sizeable issuance. This steady supply of duration exerts upward pressure on yields and reinforces our cautious approach.

Moreover, we are closely watching developments in Japan, where the narrative has turned again toward the possibility of rate hikes. Given the significant capital flows from Japanese investors to higheryielding bond markets in recent years, this could prevent the back end of yield curves from rallying commensurate with the Fed’s rate cuts.

Against this backdrop, we see limited risk-adjusted value in extending duration and prefer to maintain flexibility in our fixed income exposure. We stand ready to add exposure, should we develop more conviction that inflation risks are receding.

In currencies, we still have an overweight position in the Japanese yen. Several structural and cyclical factors are aligning in support of the yen. The likelihood of repatriation of foreign assets by Japanese investors is rising. There is also growing pressure on the Bank of Japan, with inflation persistently above target, to adjust rates. Recent comments by U.S. Treasury Secretary Scott Bessent also seem to indicate that the US is putting pressure on Japan to adjust its rates higher, presumably to lead to a higher yen versus the dollar, thereby improving U.S. competitiveness versus Japan. We think the yen will trade stronger in the medium term. We are also overweight certain high-yielding emerging market currencies, such as the Brazilian real, the Indian rupee, and the Turkish lira.

With the Fed now pivoting toward rate cuts, the environment for high-carry emerging market currencies is becoming more favourable, as investors are likely to chase higher yields in those countries.

At the other end of the spectrum, we are short the New Zealand dollar and the Swiss franc. The Reserve Bank of New Zealand is currently one of the most dovish central banks and this stance is being priced into the country’s currency, which we expect to weaken relative to the G10 universe. Finally, we continue to think the Swiss franc is expensive and its level of interest rates is unlikely to attract significant capital inflows, especially if investors turn more positive on European prospects. Accordingly, we continue to expect the currency to depreciate.