1. Introduction: Redefining the Nature of Supply Shocks

One of the most critical components of former President Trump’s second-term economic policy is the sweeping increase in tariffs. While conventional wisdom suggests that such policies may lead to stagflation through higher import prices, recent analyses from institutions like the New York Fed, the Atlanta Fed, and various former Federal Reserve officials challenge this notion. This report argues that Trump’s tariff measures are more likely to trigger a recession rather than stagflation, based on a structural interpretation of economic mechanisms.

2. The Post-Shock Trajectory: Why Inflation Won’t Be Sustained

2.1 Import Price Inflation and Expectations

According to a March 2025 New York Fed consumer survey, 1-year inflation expectations jumped by 0.5 percentage points to 3.6%, and long-term expectations hit 3.5%, the highest since 1995. This indicates that Trump’s tariffs are exerting short-term inflationary pressure.

However, this inflation is largely confined to essential goods and does not appear to be spreading through wage-induced second-round effects. Fed Chair Jerome Powell acknowledged the recent uptick in inflation but emphasized it as a transitory cost shock stemming from tariffs.

2.2 Wage and Employment Deceleration

The labor market is gradually cooling in the wake of tariff policies. Facing rising costs and uncertainty, companies are exercising caution in hiring, which has led to rising unemployment. Claudia Sahm, creator of the Fed’s Sahm Rule, noted that while this may reflect normalization, a full-blown recession could be triggered if corporate profits decline and consumption weakens. Consumer sentiment around employment is already at its most pessimistic since the pandemic.

Household wage growth expectations are also deteriorating. According to the New York Fed, expected income gains are falling, suggesting that a self-reinforcing inflation spiral is unlikely.

3. The Collapse of Consumption, Credit, and Aggregate Demand

3.1 Decline in Real Consumption Capacity

Tariff-induced price hikes in basic goods are reducing real income, leading to weakened consumption. Analysts estimate an additional $2,100 in annual household expenses, straining consumer sentiment. Some individuals are already engaging in panic buying behaviors in anticipation of economic downturns.

3.2 Deteriorating Household Credit Conditions

A February 2025 New York Fed survey showed that pessimism about household debt repayment capacity has reached its highest level since 2020. This emerging credit tightening further weakens consumption capacity, indicating a structural collapse in aggregate demand, not merely a cyclical dip.

4. Corporate Sector: Investment Freeze and Inventory Overhang

Corporations are responding to tariff shocks by cutting non-strategic expenditures. Many IT firms have significantly downgraded their 2025 investment growth forecasts and delayed hardware purchases. This illustrates how tariff-related uncertainty is constraining real investment.

A wave of inventory build-up followed by weakening demand is also underway. Toward the end of 2024 and early 2025, companies front-loaded inventory before tariffs took effect, leading to a 12.6% YoY surge in PC shipments. However, lackluster sales are now resulting in order cuts and reduced container imports—projected to fall over 20% YoY by May 2025. These developments could suppress manufacturing output and GDP.

5. Trade Balance and Global Demand Contraction

Trump’s tariff war is reducing both imports and exports, as trade partners retaliate. For example, China imposed counter-tariffs as high as 34% on U.S. goods. Consequently, global trade uncertainty has surged, with the VIX volatility index reaching post-2020 highs. New manufacturing orders in the U.S. have fallen sharply, affecting employment and capital investment across supply chains.

6. U.S. Treasury Demand: Structural Resilience in a De-Dollarizing World

6.1 Structural Foundation of Treasury Demand

The uncertainty fueled by Trump’s policies is paradoxically increasing demand for U.S. Treasuries. The dollar remains dominant across foreign exchange reserves (59%), international payments (58%), and global invoicing (54%). U.S. Treasuries are perceived as the safest and most liquid assets globally.

While China and Japan are reducing their holdings, other emerging market central banks and global asset managers are filling the gap. Domestically, MMFs, insurers, and pension funds are absorbing Treasuries using latent liquidity, as reflected in the sharp drop in the Fed’s RRP balances.

6.2 Investor-Specific Demand Profiles

• Foreign Central Banks: Maintain demand for FX reserve management and currency stability
• Global Asset Managers: Expand Treasury holdings in anticipation of rate cuts
• Pensions and Insurers: Consistent demand for long-duration assets
• MMFs and Individuals: Shift into Treasuries during equity market volatility

This multi-layered demand is underpinned not only by yield differentials but also by the liquidity and safety premium conferred by reserve currency status.

7. Conclusion: Tariffs Trigger Structural Recession, Not Stagflation

Policy shock → Cost inflation → Wage stagnation → Consumption decline → Investment freeze → Inventory correction → Rising unemployment → Aggregate demand collapse → Real economic recession

This progression suggests that Trump’s tariff policies are far more likely to result in recession than stagflation. The New York Fed’s Q1 2025 GDP Nowcast at -2.8% (down from +2.4% in the previous quarter) reflects this structural inflection.

In this framework, the primary beneficiaries are safe-haven assets like long-duration U.S. Treasuries. The losers include households suffering real income losses, firms facing collapsing demand, and export-dependent economies. Asset allocation strategies must now shift toward defensive positioning in anticipation of deeper real-sector deterioration.