A sharp rise in short-term inflation expectations, as reflected in the CPI swap curve, indicates that financial markets are now pricing in a wave of tariff-driven inflation. This development complicates the Federal Reserve’s policy path and introduces new uncertainty for investors.

A Sudden Shift in CPI Expectations Signals Tariff Pressure

In recent weeks, the U.S. inflation expectations curve has shifted significantly upward. According to Bloomberg data, the U.S. CPI fixing swap curve now shows a clear uptick compared to six months ago. Between July and October 2025, the curve jumps by about 50 basis points, suggesting a projected annualized inflation rate of around 3.2%, compared to the previous expectation of 2.6%.

This increase reflects a renewed market belief that upcoming tariffs—especially those imposed on goods imported from China—will lead to price hikes in the near term. The sharp “bulge” in the mid-curve (highlighted in the chart) marks a significant change in how the market views inflation risks heading into Q3 2025.

Trade Tensions Return to Center Stage

This market adjustment is not happening in a vacuum. It follows renewed U.S. trade hostilities, including fresh tariff proposals targeting sectors like semiconductors, EV batteries, and rare earths. While these measures are politically framed as protecting national security or reviving domestic industry, their short-term effect is a cost shock to importers and consumers.

Tariffs raise input costs for U.S. manufacturers and distributors, who are expected to pass those costs on to consumers. That process, though gradual, is already being priced into inflation expectations, even if headline CPI numbers haven’t spiked—yet.

The Fed Is Caught Between Mandates

The Federal Reserve now faces a challenging balancing act. Despite relatively stable recent inflation prints—core CPI hovering around 2.8% year-over-year—the rise in swap-implied inflation suggests that markets expect renewed pricing pressure.

If the Fed cuts interest rates prematurely, it risks fueling further inflation. But maintaining a restrictive stance for too long could squeeze economic growth and labor markets. The pricing of the front-end of the yield curve, which has steepened in recent days, shows the market is beginning to doubt the likelihood of multiple rate cuts in 2025.

In essence, tariff inflation is a supply-side shock. The Fed cannot control tariffs, but it must react to their inflationary impact, which makes policy decisions more reactive and less predictive.

U.S. Bond Markets Adjust to the New Reality

The Treasury market is already responding. Yields on short-term Treasuries have risen, while longer-term yields have remained anchored. This flattening—or inversion—of the yield curve typically signals market stress and uncertainty about the growth outlook.

Importantly, the inflation now being priced in is not demand-driven, but rather a result of cost-push pressures. Unlike in periods of overheating economies, where strong demand drives prices up, this time it’s trade policy and supply chain dynamics leading the move.

Businesses Begin Raising Prices Preemptively

According to recent business sentiment surveys, nearly 80% of U.S. manufacturers and retailers expect to raise prices in the second half of 2025. Many firms are already seeking alternative suppliers outside of China, including Southeast Asia and Latin America. But such transitions come with logistical and financial challenges that add to cost pressures in the short term.

Therefore, market pricing isn’t just theoretical—it reflects what companies are planning operationally. As these adjustments filter through to retail shelves, the impact will be felt by end consumers, leading to real inflation beyond financial modeling.

Is This the Start of a New Inflation Cycle?

The phenomenon of “tariff inflation” isn’t new. It was a prominent theme during the Trump administration, particularly in 2018–2019. However, the COVID-19 pandemic and subsequent supply chain resets put that concern on hold.

Now, with geopolitical tensions flaring again, tariff-driven inflation is back. And this time, it’s layered on top of already elevated baseline inflation, leaving little room for policy error.

Crucially, tariff inflation is not controllable by central banks. The Fed can only react to its effects, not prevent its root causes. This limits the effectiveness of traditional monetary tools in dealing with politically induced price shocks.

Conclusion: A Red Flag for Markets and Policy

The sudden rise in the CPI swap curve reflects a growing awareness: inflation may be returning—not through overheating demand, but through political decisions and global trade disruptions.

For the Federal Reserve, this presents a serious policy dilemma. For businesses, it suggests higher costs and margin pressures. For consumers, it means potentially higher prices in the months ahead. And for investors, it signals a return to volatility in interest rate expectations and inflation-sensitive assets.

Tariff inflation may not derail the U.S. economy on its own, but it could disrupt the Fed’s soft-landing scenario. In an environment where pricing power, supply chains, and policy credibility are under strain, market participants would be wise to hedge accordingly.