Investing.com -- Deutsche Bank analysts warned of a “material risk” of a U.S. recession if aggressive tariffs are implemented, arguing that the Federal Reserve may need to break conventional policy rules to respond.
In a recent note, Deutsche Bank outlined various tariff scenarios and their potential economic impacts.
They explained that the best-case scenario, in which reciprocal tariffs are limited to tariff rates or a lower share of VATs (e.g., 25%), would still push core PCE inflation 75-100 basis points above the Fed’s target but allow the Fed to keep rates on hold for the year.
However, in a mid-case scenario, growth would slow modestly below potential, while core PCE inflation could rise 1.0-1.25% above target by year-end.
Deutsche Bank said this situation could create policy tensions, forcing the Fed to consider rate cuts of up to 50 basis points, depending on factors such as labor market weakness and financial conditions.
In the worst-case scenario, the combination of higher tariffs, weakening demand, and rising unemployment could result in a mild recession.
Deutsche Bank expects the Fed to “look through” the inflation effects and cut rates below neutral, relying on disinflationary pressures from a deteriorating labor market.
“In this case, we would expect the Fed to ‘look through’ tariff-driven inflation and focus on a weakening labor market, as long as inflation expectations were not unanchoring,” said the bank.
Ultimately, Deutsche Bank argued that if economic conditions deteriorate significantly, the Fed may need to break traditional policy rules to prevent deeper economic fallout.
The bank cautioned that even without a full recession, the coming months could bring heightened uncertainty, making the Fed’s response a key factor to watch.