Tariffs Mean Higher Mortgage Rates: It's Not Magic, It's Math
Many mortgage bankers are telling realtors, homebuyers, and sellers that they see mortgage rates declining by at least 100 basis points (1%) over the next several months. They expect the Federal Reserve to lower interest rates two or three times this year in response to declining inflation and a slowing economy.
As a money manager, my livelihood depends on hard, objective data, using history as our guide. So, let’s examine the history of tariffs and how they affect mortgage rates.
To discuss tariffs and mortgage rates is like jumping from A to D without understanding B and C. What do tariffs have to do with mortgage rates? The connection becomes clear when we follow the chain of events. As Winston Churchill said, “Those that fail to learn from history are doomed to repeat it.”
The Unseen Link: How Tariffs Fuel Inflation
Historically, tariffs affect the price of goods because the tax on foreign products is largely passed on to the consumer. This isn’t just theory; it’s a well-documented economic reality.
- According to the Federal Reserve Bank of Boston, broad-based tariffs can significantly increase prices. For example, a 25% tariff could raise prices for investment goods by about 9.5% and for consumption goods by about 2.2% in the near term. In more extreme scenarios, such as a 60% tariff on Chinese imports and 10% on the rest of the world, core inflation could rise by as much as 2.2 percentage points.
- UC Davis professor Katheryn Russ explains that tariffs aren’t a visible line item on a receipt but become embedded in the prices consumers ultimately pay. Historically, tariffs have added hidden costs to consumer prices as businesses pass on the duties they pay.
- This isn’t a new phenomenon. U.S. tariffs from 1870 to 1909 led to a significant reduction in domestic productivity—by 25% to 35%—due to diminished competition and lower innovation. Reduced productivity raises the cost of goods over time, further contributing to inflation.
As Mike Patton of Forbes concludes, “Tariffs have played a shifting role in U.S. economic history. While they once protected young industries and funded the government, high tariffs have often led to trade disputes, higher consumer prices, and, in some cases, economic downturns.” The link between tariffs and inflation is real, though often indirect and delayed.
The Federal Reserve’s Historical Response to Inflation
The Federal Reserve has a dual mandate: to control inflation (the loss of our money’s purchasing power) and to foster maximum employment. It manages this primarily through the federal funds rate and its balance sheet (quantitative easing and tightening).
To understand the Fed’s potential response today, we must look to the 1970s and early 1980s. Facing runaway inflation and a recessionary economy—a condition known as “stagflation”—Federal Reserve Chairman Paul Volcker had a dilemma. The economy was suffering from rising unemployment caused by a drop in manufacturing and business uncertainty. When a pickup in demand through government stimulus ensued, inflation exploded.
The mortgage industry today argues that the Fed will choose stimulus by lowering rates to combat a slowing economy. But this view ignores the lessons of history. When Paul Volcker was faced with the same dilemma of rising unemployment and higher inflation, he chose to attack inflation first. He raised interest rates aggressively, which put the 30-year mortgage rate at an astonishing 15%. His painful but decisive action killed inflation and eventually put the economy and employment back on track. Today, Volcker is credited with making the right, tough decision.
Today’s Dilemma: Tariffs, Uncertainty, and the Powell Fed
We are seeing warning signs today that echo past challenges. A recent Financial Times article, “A warning from US factories,” noted that the manufacturing PMI has fallen below 50, which signals a contraction. The article states, “The survey showed a big fall in inventories, which could signal an end of companies’ front-loading orders to avoid the price impact of tariffs. If so, it won’t be too long before manufacturers and merchants will have to restock at higher prices, and pass on the increased costs to consumers.”
Federal Reserve Chairman Jerome Powell himself has stated that interest rates would likely be lower today if not for the looming uncertainty of tariffs. This uncertainty is heightened by the possibility that tariffs could sharply revert to higher levels set under the Trump administration unless trading partners quickly negotiate new agreements with the 90-day moratorium on the April tariff about to expire. The initial imposition of these steep tariffs triggered significant market instability with the market dropping over 19%, stoking fears of slowed economic growth and rising inflation until Trump backoff.
A sudden reimposition of tariffs could spark renewed investor anxiety, potentially resulting in a sharp decline in equity prices and a spike in interest rates—affecting housing, car loans, construction and bank lending across the board
What Will Jay Powell Do?
This brings us to the crucial question. Faced with the threat of higher inflation from tariffs and a simultaneously slowing economy, will Chairman Powell cut rates to stimulate growth, as the mortgage industry predicts? Or will he follow the historical precedent set to protect the long-term health of the economy?
Nobody knows for sure, and President Trump has put immense pressure on Powell to lower rates. However, one fact is undeniable: Jay Powell’s mentor is Paul Volcker, and history remembers exactly what he did.
