Can Policymakers Outrun Tariff Turbulence?

“Fluctuat nec mergitur” is the motto of Paris. It means: “Tempest tossed but does not sink.”

Since my last column, the global economy has endured gyrations in U.S. tariff policy, retaliation from key trading partners, major elections in Japan and Germany, and attempts to decipher the impact of generative artificial intelligence on productivity and hiring. And yet, as I write this update, the global economy is chugging along, and the equity market has rebounded strongly. Labor markets have weakened a bit but remain strong, and the feared inflation pass-through from tariffs has (yet) to curb consumer spending.

Economies function with long lead and lag times. The cost of elevated tariffs still needs to fully work through the system. Until it does, policymakers around the world are caught in a bind. Should they cut policy rates now to mitigate the impact of weaker global exports on domestic employment levels or raise rates to mitigate the impact of higher tariff-driven inflation? And do tariffs really cause persistent inflation or just a one-off change to the price level?

Despite policy volatility, equity markets have emerged tempest tossed but still afloat.

I continue to have high conviction in our central thesis—we are in an era of heightened inflationary pressure; policymakers may try to mitigate this, but the bond market will punish those who spend more than their means. Within this narrative, we see potential upside if Germany and China really commit to reflation and potential downside if the tariff situation escalates.

Over the past quarter, we have seen two major changes to global macroeconomic policy—trade and tax policy. According to Yale’s Budget Lab, the U.S. effective tariff was at 18 percent at the time of writing, substantially higher than the 2.5 percent rate at the start of the year. The lack of greater impact on the economy is due to: (1) Tariffs actually impact a small share of economic activity—only 5 percent of global GDP excluding the U.S., and (2) it’s too soon to see the new steady state of global trade—companies brought forward purchases to avoid impending tariffs, which boosted Q2 economic growth.

The U.S. was one of three major markets impacted by fiscal policy shifts. The extension of tax cuts in the One Big Beautiful Bill Act could have a positive impact on consumer spending for higher-income groups but may be offset by reduced spending from lower-income groups that will see benefit cuts. The biggest impact of the OBBB is on the U.S. fiscal position, since it is estimated to increase the federal deficit by $3 trillion over the next decade, according to the Congressional Budget Office. Near-term growth should be resilient, but the bond market will be watching the U.S. fiscal position closely.

We are in an era of heightened inflationary pressure; policymakers may try to mitigate this, but the bond market will punish those who spend more than their means.

Despite policy volatility, equity markets have emerged tempest tossed but still afloat. All major U.S. indices are back above the previous peak in late February. The bond market remains hawkish. Nominal government bond yields in Australia, the U.K. and the U.S. remain in the mid-4 percent range, despite expectations of near-term policy rate cuts.

Almost every major market—apart from China and perhaps the Eurozone—has concerns that high inflation will persist and potentially increase given trade and tax policy shifts. U.S. inflation-linked swaps are now pricing in inflation in the mid-to-high 2 percent range over the next three to 10 years. Real estate investors would be wise to focus on governments’ fiscal policy and the bond market’s reaction. Buoyant equity markets are great, but it’s the bond market that determines the cost of borrowing and the level of liquidity in the capital markets.

Sabina Reeves is chief economist & head of insights and intelligence at CBRE Investment Management, associate fellow at the University of Oxford and council member of Marlborough College. Follow Reeves on Threads: @sabinareevesconomist or on Linkedin.

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