The Fed kept interest rates higher for months due to economic uncertainty caused by Donald Trump's tariff policies. This directly increased borrowing costs for consumers on credit cards, car loans, and variable-rate mortgages, creating a tangible financial impact from political actions.

Instead of immediately passing tariff costs to consumers, US corporations are initially absorbing the shock. They are mitigating the impact by reducing labor costs and accepting lower profitability, which explains the lag between tariff implementation and broad consumer inflation.

While tariffs affect goods prices, immigration controls are reducing the labor supply, particularly in the service sector. This creates upward wage and price pressure on services, a subtle but significant contributor to overall inflation that is difficult to isolate in real-time data.

The primary economic risk for the next year is not recession but overheating. A dovish shift at the Federal Reserve, potentially from a new Trump appointee, combined with loose fiscal policy and tariffs, could accelerate inflation to 4%, dislodge expectations, and spike long-term yields.

The inflation market's reaction to tariff news has fundamentally shifted. Unlike in the past, recent tariff threats failed to raise front-end inflation expectations. This indicates investors are now more concerned about the negative impact on economic growth and labor markets than the direct pass-through to consumer prices.

Contrary to narratives about excess demand, the recent inflationary period was primarily driven by supply-side shocks from COVID-related disruptions. Evidence, such as the New York Fed's supply disruption index accurately predicting inflation's trajectory, supports this view over a purely demand-driven explanation.

The Fed expects inflation from tariffs to be a temporary phenomenon, peaking in Q1 before subsiding. This view allows policymakers to "look through" the temporary price spike and focus on what they see as a more pressing risk: a cooling labor market. This trade-off is described as the "cost of providing insurance to the labor market."

Robert Kaplan cautions against dismissing inflation risks. Many businesses are still absorbing tariff costs or working through pre-tariff inventory. He believes the full price impact will be passed on to consumers in 2026, potentially keeping inflation stickier than markets currently expect.

The economic impact of tariffs is not an immediate, one-time price adjustment. Instead, Boston Fed President Collins characterizes it as a "long one-off" process where the full effect can take months or even a year to filter through the economy. This prolonged adjustment period extends uncertainty and complicates inflation forecasting.