U.S. inflation risks are on the rise, with implications for markets, Canada

“Unfortunately, inflation hasn’t come down as much as policymakers and consumers hoped,” Craig Basinger, chief market strategist with Purpose Investments Inc., wrote in a report this week for Richardson Wealth Ltd. He noted that the U.S. Federal Reserve was “late to the game” in fighting pandemic-era inflation, and U.S. fiscal policy pulled in the opposite direction.

Inflationary pressures came down mainly because “we all blew through accumulated [pandemic] savings, and the higher cost of doing things sped this process,” Basinger wrote. “And supply or capacity caught up with demand.”

Now, certain factors are signalling that inflation could re-accelerate, Basinger said, recalling ’70s-era stagflation, when inflation increased after an initial taming.

One of those factors is tariffs and how consumers react as tariffs push prices for U.S. goods higher, Basinger said.

If higher prices result in less consumer demand, slower economic activity could help offset inflation, he said. “But, with consumer spending still resilient, and renewed fiscal spending [i.e., U.S. President Trump’s “big beautiful bill”], the economy may not slow down or slow enough to mitigate the upward move in inflation from tariffs.”

Delayed reaction

Real retail sales growth in the U.S. has been a stable 1% since December. But higher prices are beginning to emerge.

U.S. core goods prices were up nearly 4% in the past three months (annualized, and excluding vehicle prices, which fell because of increased inventories and less demand), said TD Economics in an economic Q&A posted on Wednesday. Inflationary pressures on U.S. goods “risk heating up further in the coming months, given that inbound products will be hit by the Aug. 7 reset on tariff rates,” TD said. “It may not be immediately obvious because there’s a grace period for goods in transit until early October.” 

U.S. core services prices outpaced core goods prices in July — although it’s too early to know if this trend will persist, TD said. Basinger said in the Richardson report that Purchasing Managers Index surveys for services prices have been “accelerating to the upside, which historically leads to overall inflation.”

Another inflation risk: expectations of inflation result in behaviours, such as demanding higher wages, that in turn lead to inflation, and longer-term inflation expectations are rising based on data, Basinger said. “Partial erosion of [U.S. Federal Reserve] independence, whether real or perceived, is likely adding to the view that inflation may run hotter for longer, with less effective policy control,” he wrote.

These inflation risks — tariff impacts, increased services prices, inflation expectations and fiscal stimulus — are adding up in the coming months, Basinger said.

“Of course, if we get a soft patch in the economic data, that may provide the release valve,” he wrote. “But if we don’t get a slowdown, this inflation risk may bleed into yields in the coming months.”

In a podcast on Thursday, Carrie Freestone, an economist with RBC, doubled down on a call for “stagflation lite” in the U.S., as prices increase and growth slows. She cited inflationary pressures from tariffs, which haven’t been fully captured yet by CPI data, she said. She also projected below-trend growth in consumer spending and GDP, and a continued rise in unemployment. Regarding unemployment, she noted the downward-revised U.S. jobs reports from May and June, related to trade-exposed sectors. The U.S. unemployment rate is currently 4.2% and could be 4.5% by year-end, Freestone said in the podcast.

U.S. “stagflation lite” matters to Canada, Freestone said, because slower U.S. growth in consumer spending will likely translate to weaker demand for Canadian exports. “Canada is already most overexposed to an underperforming U.S. manufacturing sector, and now tariffs just further compound that issue,” she said.

RBC Economics projects Canada’s real GDP to be 1.5% in 2025 and 1.3% in 2026.