Federal Reserve Chairman Jerome Powell has indicated that President Donald Trump’s tariffs are more substantial than anticipated, increasing the risk of further inflation. According to a recent analysis by Allianz economists, these tariffs are expected to result in a rising unemployment rate over the year, although significant layoffs are not foreseen.
In a report released on Thursday, Allianz economists stated that the U.S. labor market remains stable despite growing economic challenges, with indicators suggesting this resilience will continue through the first half of the year. They noted that the job vacancy rate could be the first sign of an impending recession, expected between the second and third quarters. However, due to a combination of supply constraints and tight immigration policies, companies are likely to retain their workforce, preventing a large increase in unemployment.
Despite the inflationary impact of significant tariff hikes and ongoing policy uncertainty, the economists do not anticipate large layoffs, as U.S. companies continue to enjoy healthy profits while facing labor shortages. They predict that unemployment will reach 5% by the first quarter of 2026, up from the March unemployment rate of 4.2% reported by the Labor Department.
The Trump administration is also making efforts to reduce the size of the federal workforce. The Department of Government Efficiency (DOGE) is continuing its downsizing initiatives, which include layoffs and buyout offers, though litigation has delayed some of these efforts. Allianz economists do not expect the workforce reductions in federal agencies to significantly impact the overall unemployment rate.
The economists further detailed that the impact of federal layoffs driven by DOGE will become apparent in employment data in the coming months. An expected decline of nearly 200,000 federal jobs this year, which could raise the unemployment rate by only 0.3 percentage points at most, would occur even if those dismissed do not find alternate employment.
As the labor market is expected to weaken steadily and tariff-induced inflation spikes during the summer, Allianz predicts that the Federal Reserve will implement interest rate cuts toward the end of 2025 and into early 2026 to support full employment.
The introduction of Trump’s “Liberation Day” tariffs initially caused investors to pivot towards safe-haven assets like U.S. Treasuries and the dollar. However, as the full scale of these tariffs and their inflationary impact became apparent, the financial markets experienced significant volatility, shifting investor focus and altering monetary policy expectations.
Allianz economists also highlighted a potential global divestment from U.S. Treasuries and the U.S. market overall. Rising U.S. yields, coupled with a weakening dollar, suggest a significant shift where major holders are not only offloading Treasuries but also reallocating investments possibly towards European markets, a move that is contrary to typical market responses to higher yields.
