Moody’s Chief Economist Mark Zandi warned today that Trump’s tariffs and immigration policies could push the United States into a state of “stagflation,” leading the Federal Reserve to consider raising interest rates in response, akin to the actions taken by former Fed Chair Paul Volcker.
(Background: Fed officials estimate two rate cuts this year, but uncertainty remains high; Bank of America: If inflation pressures persist, the Fed’s interest rates may remain frozen for two years.)
(Additional context: The Wall Street Journal criticized that inflation has risen for three consecutive months, and Trump’s initiation of a tariff war while calling for interest rate cuts is causing confusion.)
As the Federal Reserve’s efforts to combat inflation hit a stalemate, fears regarding slowing economic activity and the potential rebound of inflation due to Trump’s aggressive tariff policies have led to growing concerns among the public about the possibility of the U.S. entering a state of “stagflation.” Several economists have recently warned about the associated risks. Stagflation refers to a specific economic phenomenon characterized by stagnation, where economic growth is slow, but unemployment and inflation (continuous price increases) simultaneously rise.
According to CNBC, the dual threat of rising prices and slowing economic growth has sparked anxiety among consumers, business leaders, and policymakers, not to mention investors who have recently been selling stocks and flocking to bonds. In an interview regarding the recent market panic, Mark Zandi, Chief Economist at Moody’s, stated:
“From a directional standpoint, this is stagflation; rising inflation and slowing economic growth are the results of (Trump’s) tariff and immigration policies.”
If true, this would mark the first occurrence of stagflation in the U.S. since the 1970s (50 years). Zandi also warned Reuters last week that the market might be underestimating the risks of stagflation. In addition to tariffs, he pointed out that Trump’s policies aimed at expelling undocumented immigrants would further exacerbate inflation.
“Tariffs and immigration deportations are the roots of inflation and will harm economic growth; both are negative supply shocks. Negative supply shocks, such as soaring oil prices, led to stagflation in the 1970s.”
With U.S. economic activity slowing, concerns about stagflation are intensifying. Notably, market worries about stagflation are already reflected in various soft data. A survey conducted by Bank of America last week among global fund managers revealed that the proportion of investors expecting stagflation in the coming year reached the highest level in seven months. Consumer expectations for long-term inflation are at their peak in nearly 30 years, while overall sentiment is at a low not seen in years. According to the Personal Consumption Expenditures (PCE) report released by the U.S. Department of Commerce last Friday, consumer spending in January saw its largest decline in nearly four years, despite a significant increase in income.
On Monday, the Institute for Supply Management (ISM) released its Manufacturing Purchasing Managers’ Index (PMI), which showed that new orders in February fell by the largest margin in nearly five years, while month-on-month price increases reached their highest level in over a year. Following the PMI release, on the 3rd, the Atlanta Fed’s GDPNow indicator revised down its forecast for U.S. real GDP growth in the first quarter to an annualized decline of 2.8%. If this figure persists, it would mark the first negative growth since Q1 2022.
How will the Federal Reserve respond?
If the U.S. indeed falls into stagflation, how will the Federal Reserve react?
Mark Zandi of Moody’s warned that the Federal Reserve may still raise interest rates to curb inflation, similar to the actions taken by former Fed Chair Paul Volcker, who significantly raised rates in the early 1980s, ultimately resulting in an economic recession.
“If genuine slow growth stagflation occurs, they would sacrifice the economy.”
Stifel Chief Equity Strategist Barry Bannister predicted that the Federal Reserve might not lower rates further this year, as he believes the U.S. economy may fall into stagflation in the second half of the year under the worst-case scenario, leading to a roughly 10% decline in the S&P 500 index by year-end.
However, there are differing opinions. James Bullard, former president of the St. Louis Fed, analyzed last week that stagflation is the least desirable scenario for the Federal Reserve, but despite facing such a difficult choice, he believes the central bank may ultimately decide to cut rates. “I think they might cut rates because they believe that a slowing economy will naturally lead to a slight decrease in inflation.”
In fact, the CME Group’s FedWatch tool indicates that the market currently expects the Federal Reserve to begin cutting rates in June, potentially lowering the policy rate by three basis points (75 basis points) this year, which is one basis point higher than the previously anticipated two basis points, betting that the Fed will increase its rate-cutting efforts this year to avoid continued economic slowdown.
