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Investing.com -- The latest round of US tariffs on imports from Canada, Mexico, and China could accelerate the Federal Reserve’s path to rate cuts, according to Citi analysts.
While markets initially focused on the inflationary impact of tariffs, Citi believes their effect on economic growth will be the bigger concern for the Fed.
“Given the tight linkages in supply chains across the USMCA countries – most notably in the auto industry – tariffs left on for more than a matter of a week or two are likely to have a substantial impact on growth,” Citi wrote.
With US motor vehicle production accounting for about 2.5% of real GDP, Citi says that even a short-lived disruption could shave a percentage point from annualized GDP growth.
The bank explains that this comes at a time when economic indicators are already flashing warning signs.
The Atlanta Fed’s GDPNow model projects Q1 real GDP to contract by 2.8%, while Citi’s own estimate is a more modest 0.1% decline.
Citi notes that even before the tariffs were announced, some Fed officials were shifting to a more dovish stance. “Fed officials Musalem and Schmid, who had been relative hawks, indicated they are taking more seriously dovish downside risks to growth.”
With tariffs now in effect, inflation cooling, equity markets declining, and consumer spending slowing, Citi believes the probability of a rate cut has increased.
The firm maintains its forecast for the next Fed rate cut in May, which is now priced at 50% likelihood based on market expectations.