The more the market trusts TACO, the more Trump dares to raise taxes, and the less the Federal Reserve dares to cut interest rates

Is the US stock market trapped in a dangerous policy feedback loop? Bank of America warns that the market's calm response to Trump's tariff policy is providing room for the government to impose further tax increases, while the escalating trade war will push the Federal Reserve towards a more cautious stance. As the effective tariff rate may rise to 16% or higher, investors are facing not just short-term volatility, but the risk of stagflation that could extend until 2026. Tariff escalation far exceeds market expectations According to CCTV News, on July 4 local time, US President Trump stated that the US government would start sending letters to trade partners to set new unilateral tariff rates from that day. Trump claimed that the new tariffs would "most likely" take effect on August 1. Regarding the new tariffs to be set, Trump said, "Tariff rates could range from 60%, 70% to 10%, 20%." According to reports from the Wind Trading Desk, Bank of America analysts stated in a report on July 22 that based on the composition of imports over the past 12 months, the latest tariff announcement would raise the effective tariff rate in the US by nearly 5 percentage points to about 16%. This level far exceeds Bank of America's previous expectation of a 10% baseline scenario, constituting a significant upside risk. Trump also hinted at the possibility of imposing comprehensive tariffs of 15-20% and industry-specific tariffs on the pharmaceutical and semiconductor industries, further exacerbating the estimated upside risks. Market's calm response becomes a catalyst for policy escalation Bank of America pointed out that the market's calm response to tariff headlines may backfire. The stock market and interest rate markets showed almost no reaction to the tariff announcement, and this indifferent attitude may encourage the government to further escalate the trade war. After the passage of the fiscal bill, the Trump administration gained some buffer space to withstand a new round of uncertainty and renewed tensions with major trading partners. Bank of America maintains its structural view that the Trump administration will negotiate comprehensive bilateral agreements with various countries on issues such as trade, immigration, defense, and energy. If the market reacts strongly enough, the "Trump put option" will be triggered again. However, the uncertainty shock may be more persistent than initially expected. Even if a comprehensive trade agreement is reached, the nature of the agreement so far (maintaining a benchmark tariff of 10% or higher) poses an upside risk to the 10% baseline scenario. Stagflation Risk Intensifies, Fed's Policy Space Narrows Bank of America warns that an effective tariff rate increase of about 5 percentage points would reduce the fiscal deficit by about 50 basis points, but this has limited effect on a deficit that still exceeds 6% of GDP, while also bringing about an inflation upside risk of about 30 basis points and a downside risk to economic growth. More importantly, the latest round of tariff announcements is far from finalized, and the extension of the deadline from July 9 to August 1 indicates that there is still room for negotiation. The uncertainty surrounding tariffs itself poses a downside risk to economic growth and may weaken the stimulus effect of the "Big Beautiful Plan" on capital expenditures. Analysts state that even if tariffs are implemented on August 1, due to the "in-transit" rule, they will not be fully reflected in the data until October. Retailers typically need several months to clear their inventory, and any transmission to inflation may take even longer to manifest. If the tariffs are implemented on August 1, it will increase the risk of larger and more persistent inflation shocks, with core PCE potentially peaking at 3.5% in 2026. Against the backdrop of already deteriorating inflation expectations, large-scale cost-push shocks may also trigger more companies to raise prices, with nonlinear effects beginning to emerge, ultimately leading to real stagflation. Powell has repeatedly emphasized that the Fed wants to have a clearer understanding of the impact of policy changes before taking the next step. If there is a risk of additional significant changes to the tariff system, this clarity may not be attainable. As the stagflation shock may extend into 2026, the likelihood of the Fed being "frozen in place" increases. This aligns with Bank of America's non-consensus expectation of no rate cuts this year. Analysts acknowledge that if the labor market deteriorates, the Fed may be forced to take action. However, the unemployment rate fell to 4.1% in June, and the number of initial jobless claims has returned to normal after experiencing seasonal growth in June, with no clear signs of loosening in the labor market currently visible