According to the research report released by CICC, Trump has threatened to fire Powell, putting U.S. monetary policy in the spotlight. The Federal Reserve's policy will depend on the outlook for tariff policies, adopting different monetary policies in different scenarios. Under high tariff conditions, the Federal Reserve may cut interest rates more quickly and significantly. This is because the damage caused by high tariffs to the economy will raise unemployment rates and increase the risk of recession, thereby forcing the Federal Reserve to cut rates in response.
In this scenario, CICC expects the Federal Reserve to begin cutting rates in July, potentially implementing a one-time significant cut of 50 basis points, with an annual rate cut of up to 100 basis points, and the federal funds rate may drop to 3.5% by the end of 2025. For the market, this type of rate cut is considered a &#34;bad rate cut,&#34; as it would reinforce market concerns about recession, leading to suppression of risk assets like stocks, while safe-haven assets like bonds would benefit.
<h2>I. The Substitution Effect of Tariffs</h2>
Tariffs are an addition to existing prices, changing the relative prices between imported goods and domestic goods, as well as between tariffed goods and non-tariffed goods. Generally, when tariffs push up the prices of imported goods, consumers will shift their demand to domestically produced goods or goods from non-tariffed countries, known as the &#34;substitution effect.&#34; If the supply of substitutes is sufficient, the price of taxed products may not rise; however, if it is difficult to find substitutes, a general price increase may occur.
One case is the tariffs imposed by the U.S. on imported washing machines. From 2012 to 2018, the U.S. imposed additional tariffs on imported washing machines three times. In 2012 and 2016, anti-dumping duties were imposed separately on washing machines imported from Mexico, South Korea, and China, leading to a decrease in the number of washing machines imported from these countries. However, the prices of washing machines in the U.S. CPI basket did not rise, as consumers switched to purchasing washing machines imported from Thailand and Vietnam, thus achieving the substitution effect through &#34;country switching.&#34; Subsequently, in 2018, the U.S. imposed comprehensive &#34;safeguard tariffs.&#34; Since this covered almost all washing machine supplying countries, consumers found it difficult to find substitutes, causing the washing machine price index to jump by 17%.
Chart: Significant Increase in U.S. Washing Machine Prices After Comprehensive Tariffs in 2018
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/7adad0e3c06d4d9be957ce0b0329a4ba.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/7adad0e3c06d4d9be957ce0b0329a4ba.jpg"/>
Source: Haver, CICC Research Department
In the price increase of 2018, the prices of washing machines from domestic brands such as Whirlpool, Maytag, and General Electric (G.E.) also rose by 5-17%, showing no significant difference compared to the price increases of foreign brands Samsung and LG[1]. This indicates that domestic producers take the opportunity to raise prices when consumers lack substitutes; if comprehensive tariffs are implemented, it will more easily lead to a general price increase. According to research by Amiti et al. (2019), after the U.S. imposed tariffs in 2018, the price increase of domestic goods was comparable to the tariff rates, indicating that the tariff costs were almost entirely passed on to U.S. consumers and importers[2]
Cavallo et al. (2021) found that since 2018, despite the appreciation of the US dollar, Chinese exporters have not significantly lowered prices, with most tariffs absorbed by US importers[3].
Another type of substitution effect is the substitution between goods consumption and services consumption. For example, when the price of televisions rises, consumers may postpone purchasing a television and spend their TV watching time on other entertainment activities, such as going to the movies or traveling, which may lead to an increase in demand for movies and travel services, thereby driving up the prices of these services. Similarly, when car prices rise, consumers may abandon their plans to buy a car and instead opt for renting a car, which may increase demand in the car rental market and raise rental service prices.
Due to the magnitude and scope of the tariffs imposed by Trump far exceeding those in 2018, and with relatively limited supply of substitutes, the likelihood of price increases for taxed goods is high. The &#34;reciprocal tariffs&#34; introduced by Trump on April 2 cover almost all US trading partners, and if they cannot be canceled through negotiations, the role of importing substitutes from other countries will be very weak. Additionally, domestic brands, protected by tariffs, are likely to leverage their market power to raise prices. Moreover, the US has just experienced high inflation post-COVID-19, and consumers have developed a certain inflationary mindset, making it more &#34;natural&#34; for companies to raise prices. These effects interact and accumulate, potentially leading the US to face a compounded inflation effect.
<h2>II. Revenue Effect of Tariffs</h2>
Tariffs are essentially a form of taxation imposed by the state, and like other tax policies, they reduce the net assets of the private sector, leading to a decline in economic demand. For consumers, tariffs not only reduce their real income but also the resulting stock market decline can shrink household wealth, suppressing consumption expenditure. This channel is referred to as the &#34;income effect.&#34;
Since Trump imposed additional tariffs, consumer confidence in the US has continued to decline, with increasingly pessimistic expectations regarding future employment and wealth. According to a survey by the University of Michigan, the consumer confidence index dropped significantly to 50.8 in April 2025, nearing historical lows. According to a survey by the New York Federal Reserve, the average probability that consumers believe the unemployment rate will rise in the US a year later surged to 44%, the highest since the COVID-19 pandemic began in April 2020. Nearly one-third of households expect their financial situation to worsen a year from now, the highest level in nearly two years. The Conference Board's survey shows that consumer expectations for the stock market have weakened, with the proportion of consumers expecting stock prices to decline over the next 12 months having risen significantly since the beginning of the year.
Chart: Significant Decline in US Consumer Confidence Index
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/aa5f30c0e36dc984325c89ccb189b72f.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/aa5f30c0e36dc984325c89ccb189b72f.jpg"/>
Source: Wind, CICC Research Department
Chart: Deterioration of US Residents' Expectations for Employment Prospects
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/e2aa414538a70b0e69149b932b00b0ee.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/e2aa414538a70b0e69149b932b00b0ee.jpg"/>
Source: New York Fed, CICC Research Department
Chart: American residents' expectations for stock price increases weaken
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/8dc1efd2e7c3567b7703c175eeae2030.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/8dc1efd2e7c3567b7703c175eeae2030.jpg"/>
Source: The Conference Board, Haver, CICC Research Department
Some consumer spending has shown signs of slowing down. For example, hotel and airfare prices in the U.S. have been declining since the beginning of the year, indicating a weakening demand for travel. On one hand, consumers are anxious about future prospects, leading them to cut back on travel spending. On the other hand, uncertainty in the economic outlook has caused businesses to reduce business travel, while government spending cuts have also lowered official travel. Additionally, the number of non-U.S. citizens arriving in the U.S. by air in March fell nearly 10% year-on-year[4], indicating that foreign tourists are also avoiding travel to the U.S. This may be related to increased public resentment due to tariffs, concerns over geopolitical friction, and global economic uncertainty, with some countries and institutions advising against travel to the U.S. Furthermore, the personal savings rate in the U.S. has slightly rebounded this year, which may indicate that American residents are increasing precautionary savings by cutting back on spending for goods and services to cope with economic and policy uncertainties.
Chart: U.S. personal savings rate has rebounded
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/d152466e65ad9cd2ed3bfbec3781e15d.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/d152466e65ad9cd2ed3bfbec3781e15d.jpg"/>
Source: Wind, CICC Research Department
In terms of inflation impact, the &#34;income effect&#34; of tariffs will reduce inflationary pressure, which is contrary to the path of the &#34;substitution effect&#34; that raises prices. In other words, although some prices may rise due to tariffs, if consumers' actual income and wealth decline, the overall slowdown in demand may still suppress inflation. From this perspective, the persistence of this inflation may not be as strong as that of the inflation cycle in 2021-22, when the U.S. pushed for fiscal expansion to cope with the pandemic, while monetary policy was very loose, stimulating demand. However, this time there is no demand-side stimulus, and monetary policy is relatively tight, which does not support sustained inflation.
<h2>III. Inflation and Employment Paths Under Different Tariffs</h2>
As analyzed above, the impact of tariffs on inflation depends on whether the substitution effect or the income effect dominates, which in turn depends on the magnitude of the tariffs. Due to the erratic nature of Trump's policies, and Treasury Secretary Yellen stating that the U.S. will negotiate with trade partners within the next 90 days[5], we consider two tariff scenarios: the first scenario is that negotiations lack substantial progress, and tariffs remain high after 90 days. The Trump administration maintains a 10% base tariff on major trading partners, a 25% tariff on imported cars and parts, and tariffs on China, corresponding to an effective tariff rate of 28.4%. The second scenario is that negotiations yield effective results, and tariffs are reduced within 90 days
With trade partners reducing trade barriers with the U.S., the Trump administration has also substantially cut some previously proposed tariff measures, lowering the effective tariff rate in the U.S. to about 15.4%.
Chart: Two Scenarios for Future Tariffs: Maintaining High Tariffs vs. Reducing Tariffs
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/3dd652b61472583875865a5ba9a25c12.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/3dd652b61472583875865a5ba9a25c12.jpg"/>
Note: 1900-1918 and 2024 are U.S. government fiscal years, 1919-2023 are calendar years, and 2025 is an estimate by the author.
Source: USITC, Wind, CICC Research Department
In the scenario of maintaining high tariffs, CICC expects the tariff's upward pressure on commodity prices to begin to manifest from May (as some companies had previously imported and prepared some inventory), continuing into the third quarter. Consumer purchasing power declines, leading to a tendency to &#34;save more and consume less,&#34; with demand significantly weakening. The income effect may outweigh the substitution effect, causing prices to shift from an initial rise to a decline. In this case, CICC expects the year-on-year growth rate of core CPI at the end of the second, third, and fourth quarters of 2025 to be 3.3%, 3.7%, and 4.1%, respectively, with a decline starting in 2026, and core CPI inflation dropping to 2.2% by the end of the fourth quarter.
In the scenario of reducing tariffs, due to the lower tariffs, the upward pressure on inflation is relatively smaller, and the extent of economic demand slowdown is also smaller. The substitution effect may outweigh the income effect, resulting in stronger persistence of inflation. CICC expects the year-on-year growth rate of core CPI at the end of the second, third, and fourth quarters of 2025 to be 2.8%, 3.2%, and 3.6%, respectively, with a decline to 2.6% by the end of the fourth quarter of 2026.
Chart: Path of U.S. Core CPI Inflation under Different Tariff Scenarios
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/438c98d854b8d9a89bdc536d97f2bf42.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/438c98d854b8d9a89bdc536d97f2bf42.jpg"/>
Note: We assume that U.S. consumers and overseas producers share the tariff losses equally, meaning half of the cost increase is passed on to U.S. consumers, while the other half is borne by trade partners.
Source: Haver, CICC Research Department
The unemployment rates under the two scenarios also show different trends. CICC's estimates indicate that in the scenario of maintaining high tariffs, the U.S. real GDP growth rate may decrease by 1.4 percentage points, corresponding to an annual unemployment rate increase of about 1 percentage point, with the unemployment rate potentially rising to 5.1% by the end of the fourth quarter of 2025. In the scenario of reducing tariffs, the impact on real GDP is about 0.7 percentage points, with the unemployment rate potentially increasing by 0.5 percentage points, leading to an unemployment rate of 4.6% by the end of the fourth quarter of 2025.
<h2>IV. Two Paths for Federal Reserve Rate Cuts</h2>
Tariffs pose significant challenges to the Federal Reserve's monetary policy, with the difficulty lying in whether to respond to high inflation or to look through the temporary price increases and focus on the average trend of inflation
CICC believes that the Federal Reserve's policy will depend on the outlook for tariff policies, adopting different monetary policies in different scenarios.
In the scenario of maintaining high tariffs, the Federal Reserve may cut interest rates more quickly and significantly. This is because the damage caused by high tariffs to the economy will raise unemployment rates and increase the risk of recession, thereby forcing the Federal Reserve to cut rates in response. In this scenario, CICC expects the Federal Reserve to start cutting rates in July, potentially implementing a one-time significant cut of 50 basis points, with the total rate cut for the year possibly reaching 100 basis points, and the federal funds rate may drop to 3.5% by the end of 2025. For the market, this type of rate cut is considered a &#34;bad rate cut,&#34; as it would reinforce market concerns about recession, which may suppress risk assets like stocks while benefiting safe-haven assets like bonds.
In the scenario of lowering tariffs, the timing of rate cuts will be more delayed, and the number of cuts will be fewer. Since the impact of tariffs on the economy is not as severe, the Federal Reserve will remain patient and may wait until the fourth quarter when prices are no longer rising significantly before starting to cut rates. In this scenario, CICC expects the Federal Reserve to cut rates only once in 2025, possibly in December.
Chart: Two Paths of Federal Reserve Rate Cuts: The Higher the Tariff, the More Cuts
<img src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/13331f7e003a16daf1597562e50f1258.jpg?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/http://img.zhitongcaijing.com/images/contentformat/13331f7e003a16daf1597562e50f1258.jpg"/>
Source: Haver, CICC Research Department

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CICC expects that under high tariffs, the Federal Reserve may cut interest rates faster and more significantly to address the risks of economic damage and rising unemployment. It is anticipated that the Federal Reserve will begin cutting rates in July, possibly implementing a one-time cut of 50 basis points, with a total reduction of up to 100 basis points throughout the year. By the end of 2025, the federal funds rate may drop to 3.5%. This rate cut is seen as a "bad cut," which could exacerbate recession concerns in the market, suppress risk assets such as stocks, and benefit safe-haven assets like bonds

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CICC: High tariffs may trigger the Federal Reserve's "recession-style" interest rate cuts