Investors, Are We Barreling Toward More Inflation?

The Fed’s latest rate cut comes as inflation ticks back up to 2.6%. Although the second rate cut in 2024 was only half the size of the first one at 0.25%, it still signaled confidence in the downward trajectory of inflation, but that might need a serious reassessment.

With the reelection of Donald Trump to the presidency, some economists have suggested that the future rate cuts are in doubt. It’s been long contested that the incoming administration’s economic policies are potentially inflationary, which would undoubtedly put the brakes on further rate cuts.

Could Trump’s presidency reignite inflation? What economic impact would his most widely quoted proposals have, and it will only lead to more speculation about the Jerome Powell and the Federal Reserve’s repsonse.

The Tariffs Question

Most of the discussion about the potential economic consequences of Trump’s second presidency revolves around the promise to impose tariffs on all imported goods. The highest tariffs, at 60%, would apply to goods imported from China. Mexico could see tariffs of as high as 25%, while all other countries could be subject to tariffs of 10% or more.  

Most economists and business analysts are worried that the tariff policy would be inflationary. Nobel Prize-winning economist Simon Johnson told Time magazine, “There’s a lot of inflationary pressure in his [Trump’s] promises.”

First, tariffs would almost certainly pass the increased importing costs on to consumers. According to The Budget Lab at Yale, the prices of consumer goods would rise by anywhere between 1.4% and 5.1% “before substitution.” And that’s the thing about tariffs: They’re not necessarily a terrible idea if whatever it is that’s being imported is simultaneously being substituted by an equivalent domestic product. 

One of the lone voices who did not oppose the idea of tariffs even back in 2022 was the Economic Policy Institute (EPI), which pointed out that Trump’s first attempt at imposing tariffs didn’t have uniformly negative consequences. For example, there were positive developments in the U.S. aluminum and steel industries, which saw more new projects, investments, and jobs.  

The issue, however, was that “many of Trump’s tariff hikes lacked a strategic purpose and end goal, and there was no underlying policy effort made to restore American competitiveness,” said EPI’s report. Without this type of effort, tariffs simply pass the increased costs on to consumers because importers aren’t able to switch to nonexistent domestic alternatives.

In addition, modern supply chains are complicated; some of them are so complex that manufacturers may not be able to easily extricate themselves from existing production operations. This is the case in electronics, for example. 

The other major issue with tariffs is the effect of retaliation from trade partner countries. As the Yale Lab report makes clear, while a scenario in which there was no retaliation would raise $2.6 trillion over the next decade, or 0.7% of U.S. GDP, if trade partners retaliate with their own tariff measures, it would reduce this revenue by anything between 12% and 26%.

The U.S. is an exporting nation as well as an importing one—something that can easily be forgotten when tariff policies are being implemented. If whole industries are majorly impacted by retaliatory measures, they begin needing subsidies, which reduces any net benefits from tariffs even more. 

For example, U.S. farmers needed subsidies during the 2018-19 trade war. Those subsidies amounted to 92% of the revenue collected from import duties.   

Finally, tariffs reduce competition over time, which means that domestic manufacturers raise prices anyway because they now can. Higher production costs would also disincentivize production, meaning less consumer choice at higher prices. 

Whichever way you look at it, tariff policies tend to increase what’s known as experienced inflation—that is, the prices of goods and even housing (we’ll get to housing in a bit). 

The ‘‘Drill, Baby, Drill” Question

But what if tariffs are a red herring, and any economic harm they may do will be eclipsed by the promised increase in domestic oil and gas extraction?

Trump famously promised a 50% reduction in energy costs for households back in August. In theory, if this massive cost reduction could somehow be achieved, it would mitigate the inflationary pressures created by Trump’s other policies.

Travis Fisher, director of energy and environmental policy studies at the libertarian Cato Institute, told Fact Check that “all else equal, more energy production in the U.S. would reduce prices overall,” elaborating that “significant reductions in the cost of all energy resources would mitigate overall price increases, because energy is a costly input into nearly every good and service sold.”

The problem, however, is that the U.S. is part of the global supply chain in fossil fuels. This makes oil prices, in particular, “difficult to move because they are established by global supply and demand,” according to Fisher. Oil companies are highly unlikely to want to vastly ramp up their production at reduced prices since it would significantly affect their profit margins.

Interestingly, the Biden administration was also moving in the direction of increased oil production. Record quantities of oil were extracted in 2023. And yet the Consumer Index for Household Energy climbed under Biden.

So, in theory, extracting more fossil fuels domestically should lower prices, but there’s no guarantee that it will. Sanjay Patnaik, director of the Center on Regulation and Markets and a senior fellow in economic studies at the Brookings Institution, told Fact Check that oil and gas prices are “largely out of the hands of the presidency” because they are part of a “very complex economic picture.”

The Immigration Question

Now, let’s turn to immigration. Much has already been said about the potentially inflationary impact of the drastic measure of deportation on farming and the cost of food in the U.S. So, instead, let’s consider the potential impact on the housing sector. 

The argument for mass deportations mainly rests on the idea that freeing up millions of housing units would reduce current pressures on the housing market and make housing more available and affordable. The reality is, once again, more complex than the proposed zero-sum game. 

Objections to the proposed plans have already been raised by members of the construction industry. Jim Tobin, CEO of the National Association of Home Builders, told Investopedia in October that while it is true that the industry needs to increase its “supply of American-born workers,” the current reality is that “the demand in our industry is so high that we rely to a large extent on immigrant labor. Anytime you’re talking about mass deportations, you risk disrupting the labor force in our industry.”

Census data by the National Association of Home Builders shows that, as of 2022, about a third of all construction workers were foreign-born. In some parts of the country, notably in Texas, the share is closer to 40%. Losing that labor force would eventually drive up housing prices because of increased labor costs.

For fairness’ sake, it’s worth noting that immigration overall drives up the cost of housing. According to a 2017 study, a 1% increase in population in an area drives up rents and housing prices by 0.8%. So immigration is a factor in housing costs, but it is important to put it in perspective. Home prices have gone up 50% since the start of the pandemic; rents went up by 30%. 

As Chloe East, an associate professor of economics at the University of Colorado Denver, told NPR, “While undocumented immigrants may play a small role in increasing housing prices in some areas, the majority of the reason that we’re seeing increases in housing prices is other factors separate from undocumented immigration.” 

The main reason identified by the economists is the chronic underbuilding of new homes, which has been an issue since at least 2008. Mass deportations, by the way, were undertaken both by the Bush administration, which deported 10 million undocumented migrants and by the Obama administration, which deported 5 million. Neither event correlated with any significant improvement in housing affordability. They did result in construction labor shortages. 

As for the question of sheer availability: Won’t deporting a lot of people simply free up housing that’s already there? The truth is that undocumented migrants rarely live in the type of housing preferred by legal U.S. residents: they typically can’t afford it. Sharing smaller rented apartments is common, especially in communities where people work in construction. Ligia Guallpa, executive director of the Workers Justice Project, told Yahoo! Finance that “very often, where workers build are not places where they can afford to live.”  

What About All Those Building Restrictions?

Since we’re on the subject of housing, Trump may be on to something with his proposals to cut some of the regulatory red tape that currently hampers new construction and increases building costs. Regulatory costs add over $90,000 to the cost of building a new home, as of 2021 figures. Cutting at least some of that could deliver tangible benefits for both construction firms and homebuyers. 

As Ralph McLaughlin, senior economist at Realtor.com, told Investopedia, “There is pretty strong consensus among housing economists that the primary structural problem in the U.S. housing market stems from a very long period of underbuilding homes in this country due to unnecessarily strict land use regulations.” 

So, Trump’s idea about repurposing federal land for new construction? If it works out, this might actually be the policy that has a tangible positive outcome for the housing market. 

Final Thoughts

Without a doubt, Trump’s second term as president will bring about a lot of economic change. How drastic it will be won’t be apparent on day one but rather unfold over months and years.

The key question going forward is what the Federal Reserve does in response to rising inflation numbers and the possible fallout from new economic policies. Will we see mortgage rates higher for longer? It’s far too early to know.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.