Opinion
Donald Trump’s “diesel-for-sanctions” deal with Vladimir Putin is an indication of how desperate he has become in the lead-up to next month’s midterm elections. Rather than seeking to shift blame for his polling woes to Ukraine, he should look in the mirror.
When the latest inflation data is released on Wednesday morning in the US, it is expected to show that the inflation rate in the world’s largest economy rose again in September, adding to the cost-of-living pressures that are the key issue in the midterms.
The consensus among US economists is that headline inflation will have risen from August’s 3.4 per cent to 3.6 per cent or 3.7 per cent, with “core” inflation (excluding energy and food costs) either steady or edging up from 2.5 per cent to 2.4 per cent.
That disparity between headline and core rates points to the major factor in the persistently high US inflation rate – the surge in gasoline and diesel prices that has occurred as a result of Trump’s decision to go to war in the Middle East.
The day before the February attacks by the US and Israel on Iran, oil was trading at $US70 a barrel. Today it is above $US106 a barrel.
US gasoline prices average $US2.28 ($3.27) a gallon on the eve of the attacks. Today, they average $US4.35 ($6.24) a gallon.
Diesel cost, on average, about $3.80 a gallon on February 27. Today, it is $US6.27 a gallon.
As has often been the case with Trump, his ego and impulses – in this case the desire to bend the Fed to his will, or in the war with Iran, his expectations of an easy and glorious victory – undermine his ambitions.
Those increased costs not only feed directly into households’ costs of living, but they also, over time, bleed into the wider economy as the delayed impact on transport costs and agricultural production flows through and impacts consumer prices and corporate margins.
When the members of the Federal Reserve Bank’s Open Market Committee meet in a fortnight to decide whether to raise their policy rate for a second successive meeting, however, they won’t just be considering the direct and indirect costs of energy.
The focus on energy costs has tended to relegate the other major Trump-inspired source of inflation to the sidelines of discussion - but, as with fuel prices, the impact of his tariffs is still working its way through the US economy.
The New York Fed produced a research paper last year that concluded that about 90 per cent of Trump’s 2025 tariffs were passed through to US import prices and were absorbed by domestic businesses and consumers.
Last week, the Fed researchers produced an update. They found that for every percentage point increase in average tariffs, consumer prices increased by about a quarter of a per cent after one year.
About two-thirds of the effect arose because tariffs raised the prices of imported goods, while the rest arose indirectly as US companies paid more for imported parts and materials and because US producers raised their prices when competing imports cost more.
A good illustration of the second round effects of the tariffs is steel, where Trump imposed a 50 per cent tariff on imports in February last year. US steel prices have risen faster than anywhere else in the world, with hot-rolled coil prices up more than half.
That’s great and immensely profitable for the handful of US domestic steel mills, but not so great for downstream manufacturers and, ultimately, US consumers.
The Fed analysis found that the direct effect of higher import prices flowed through quite quickly. About half the increased costs were in place after three months and all of them by six months, with retailers taking a few months to lift their prices.
The indirect effects – the increased input costs to US manufacturers – took longer to surface. In the first six months, US producer prices rose slightly, but the response then builds and roughly doubles over the next six months, they said.
Most of Trump’s baseline tariffs on the rest of the world were implemented, with delays, in the middle of last year.
Having been deemed illegal by the Supreme Court in February, those “Liberation Day” tariffs were quickly replaced by interim tariffs with a uniform rate of 10 per cent, until they were in turn displaced by the “forced labour” tariffs of either 10 per cent or 12.5 per cent on 60 economies that Trump announced in July this year.
There are, of course, other sector-specific tariffs that Trump imposed last year on “national security” and other grounds, like those on steel and aluminium, but the significant point here is that the tariffs have been a moving feast and that the delay before their full impact on end-prices is felt means they are still feeding into the inflation rate.
The Fed researchers said that, in a scenario where a 10 per cent tariff is imposed on all imports (which is the base case for Trump’s forced labour tariffs) consumer goods prices would be 2.6 per cent higher after 12 months, or about a quarter of the tariff increase.
Thus, the impact of both higher energy costs as a result of the war on Iran and higher consumer goods prices due to Trump’s tariffs is still flowing through the US economy.
The inflation rate also isn’t being helped by the massive investments being made in artificial intelligence and its flow-on effects to the prices of capital, semiconductors, construction costs and electricity and water.
AI companies are spending about $US750 billion ($1.1 trillion) this year and are forecast to spend at least another $US2 trillion (if the boom in the sector lasts) over the next two years. In the long run, AI may (or may not) increase productivity and decrease inflation rates but, in the near term, the frenzy adds to inflation.
Trump’s deal with Putin will have a minor impact on US diesel prices, if any. The volumes of diesel are too small to have a material effect.
If the war in Iran ended tomorrow, it would have a much greater impact, even though it might take months and, in some instances years, for the damage done to infrastructure in the Middle East and confidence in passing through the Strait of Hormuz to be fully remedied and supplies of oil and refined products to be fully restored.
Similarly, if Trump stopped announcing new tariffs, or better still withdrew all those he’s put in place or has announced, the inflation rate would subside and probably be very close to the Fed’s 2 per cent target. Prices would still be higher than before the Iran war and his trade wars, but stable.
Unless there is an increase in the inflation rate above expectations this week, the Fed is likely to sit on its hands later this month rather that raise rates again days before the midterms.
Market expectations have fallen back from a near-certainty of another 25 basis point increase following Fed chairman Kevin Warsh’s hawkish commentary after last month’s meeting. They are now pricing in a less than 20 per cent chance that the Fed will move again this month. A rate rise is fully priced in for December.
In any event, a cut in interest rates to the 1 per cent or less that Trump consistently calls for aren’t going to happen while the inflation rate remains pumped up by his war and tariffs – unless he can find another solution.
And he thinks he has one. The administration is again targeting Fed governor Lisa Cook, with Trump setting up a “committee of inquiry” staffed by three Trump loyalists, including his key economic adviser, the obsequious Kevin Hassett, into allegations made by another fiercely loyal Trump appointee that Cook committed mortgage fraud by making false statements on a loan application.
The inquiry came after the Supreme Court ruled that Cook had been denied procedural fairness when Trump sought to fire her “for cause” from the Fed’s board. Should the “kangaroo court,” as it is being described by Cook supporters, do what Trump wants, the matter will inevitably end up before the Supreme Court again.
The unintended consequences of the campaign against Cook is that another Trump target, former Fed chair Jerome Powell, will probably continue to defy convention and remain on the Fed’s board until his term ends in January 2028 rather than risk the damage to the Fed’s independence that could arise if Trump were able to stack the board. Other Fed governors – including Warsh – might also be emboldened, if only to protect their own reputations.
As has often been the case with Trump, his ego and impulses – in this case the desire to bend the Fed to his will or, in the war in Iran, his expectations of an easy and glorious victory – undermine his ambitions.
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