Moody’s Chief Economist Mark Zandi warned today that Trump’s tariffs and immigration policies could plunge the United States into “stagflation,” with the Federal Reserve possibly opting to raise interest rates in response, similar to the actions of former Fed Chair Paul Volcker.
(Background: Fed officials estimate two rate cuts this year, but uncertainty is high; Bank of America: If inflation continues to be a headwind, Fed rates may remain frozen for two years.)
(Background Supplement: The Wall Street Journal harshly criticized: Inflation has risen for three consecutive months, and Trump’s initiation of a tariff war while calling for rate cuts is simply chaotic.)
As the Federal Reserve’s efforts to combat inflation have become stalled, fears of a slowdown in economic activity and the potential rebound of inflation due to Trump’s aggressive tariff policies have heightened concerns that the U.S. may fall into “stagflation.” Several economists have recently warned of this risk.
Stagflation, defined in economics, refers to a situation where economic stagnation occurs alongside rising unemployment and inflation (persistent increases in prices).
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 hoarding bonds.
In response to the recent market panic, Mark Zandi, Chief Economist at Moody’s, stated in an interview:
“From a directional standpoint, this is stagflation; rising inflation and slowing economic growth are the results of (Trump’s) tariff and immigration policies.”
If this is accurate, it would mark the first occurrence of stagflation in the United States since the 1970s (50 years). Zandi also warned Reuters last week that the market may be underestimating the risks of stagflation. In addition to tariffs, he pointed out that Trump’s policies to expel undocumented immigrants would also exacerbate inflation.
“Tariffs and the expulsion of immigrants are the root causes of inflation and will harm economic growth; both are negative supply shocks. Negative supply shocks, such as skyrocketing oil prices, led to stagflation in the 1970s.”
U.S. Economic Activity Slows, Concerns Over Stagflation Intensify
It is noteworthy that market concerns about stagflation have been reflected in various soft data. A survey conducted by Bank of America last week among global fund managers indicated that the proportion of investors expecting stagflation in the coming year reached a seven-month high.
Consumer expectations for long-term inflation are at a near 30-year peak, while overall sentiment is at a multi-year low. According to the Personal Consumption Expenditures (PCE) report released by the U.S. Department of Commerce last Friday, despite significant increases in income, consumer spending in January saw the largest decline in nearly four years.
On Monday, the Manufacturing Purchasing Managers’ Index (PMI) released by the U.S. Institute for Supply Management (ISM) indicated that new orders in February fell by the largest margin in nearly five years, while monthly price increases were the highest in over a year.
Following the release of the PMI data on March 3, the GDPNow indicator from the Atlanta Federal Reserve downgraded its forecast for U.S. real GDP growth in the first quarter to an annualized decrease of 2.8%. If this figure holds, it would represent the first negative growth since Q1 2022.
Will the Federal Reserve Raise Rates in Response?
If the U.S. does indeed fall into stagflation, how will the Federal Reserve respond?
Mark Zandi from Moody’s cautioned that the Federal Reserve may still raise interest rates to curb inflation, similar to the approach taken by former Fed Chair Paul Volcker, who significantly raised rates in the early 1980s, resulting in a recession.
“If stagflation with truly slow growth occurs, they will sacrifice the economy.”
Stifel Chief Equity Strategist Barry Bannister predicted that the Federal Reserve may not further lower rates this year, as he believes the U.S. economy could enter stagflation in the second half of the year, leading to a roughly 10% decline in the S&P 500 by the end of the year.
However, there are differing views. Former St. Louis Federal Reserve President James Bullard analyzed last week that stagflation is the scenario the Federal Reserve least wants to see. Despite facing this difficult choice, he believes the central bank may ultimately decide to cut rates, stating, “I think they may lower rates because they believe that the slowdown in the economy will naturally lead to a slight decrease in inflation.”
In fact, the CME Group’s FedWatch tool shows that the market currently expects the Federal Reserve to begin lowering rates in June and may cut 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 ramp up rate cuts this year to prevent ongoing economic slowdown.
