Key Takeaways
• As new tariffs are implemented amid sticky inflation and slowing growth, some market watchers are sounding the alarm about stagflation.
• Stagflation is a rare economic scenario of high inflation and stagnant economic growth.
• Such a scenario puts the Federal Reserve in a bind.
• Economists say the risk of stagflation is rising but still relatively low—for now.
• Markets are struggling with a lack of clarity on trade policy and the changing growth outlook.
There’s a new buzzword on Wall Street, and it’s not good for investors: stagflation. This refers to high inflation and a stagnant economy—a thorny and uncommon scenario for the US. “You may get one of these things or you may get the other, but it’s rare to get stagflation,” explains Gus Faucher, chief economist for PNC Financial Services Group.
For most, stagflation probably brings to mind the 1970s, when twin oil shocks sent energy prices soaring amid a painful economic contraction. Today the specter returns as President Donald Trump ramps up tariffs on the United States’ largest trading partners, stoking fears of rising prices and a weakened labor market at a time of sticky inflation when economic growth was already expected to slow.
“The odds are uncomfortably high that we enter a stagflation environment, because there seems to be an intent to pursue tariffs to their full extent,” says Greg Daco, chief economist at EY. “And if you implement the tariffs to their full extent, then you will have the ingredients to promote stagflation.
Other Trump policies could fuel the fire. “You could see inflationary impact coming from restrictions on immigration—a tighter labor market, stronger wage growth,” Faucher explains. “And those policies could also weigh on economic growth.“
Could Tariffs Cause Stagflation?
Investors are grappling with an uncertain growth outlook and a lack of clarity on trade policy, as tariff decisions are made and reversed within days. On Tuesday, new tariffs of 25% took effect on imports from Canada and Mexico, along with a further 10% tax on imports from China, sending global markets lower. Trump subsequently delayed levies on automakers, and on Thursday, he pared back tariffs on Canada and Mexico for an additional month.
The president has signaled that reciprocal tariffs and tariffs on other major imports like steel and aluminum are planned. Analysts warn of major economic consequences if the new levies are implemented in their current forms. “Tariffs are a classic stagflationary shock,” explains Brian Rose, senior US economist at UBS Global Wealth Management. “It’s a tax hike that also pushes up prices.” And in the short term, “there’s no doubt that this is negative for growth.” He says it’s reasonable to expect many firms to pass higher import costs on to consumers.
Meanwhile, reduced competition from abroad makes it easier for domestic firms to raise their prices. And companies waiting for more clarity on tariffs may slow or even suspend some operations, especially if they think the new taxes are temporary. “We were expecting some slowdown [in growth], but we think these latest tariffs on Canada and Mexico are a relatively large shock,” Rose says. If they remain, economic growth will take “a substantial hit.”
Inflation and Growth Outlook
The tariffs come amid a slew of weaker-than-expected economic data that has rattled investors. Last week, a report from the Conference Board showed consumer confidence falling the most since August 2021 while inflation expectations jumped. Retail sales also slowed in January. Data from February showed a decline in construction spending and manufacturing activity.
One closely watched model of gross domestic product growth from the Atlanta Fed indicates that growth may have contracted at a 2.8% rate in the first quarter of 2025. That would be a sharp reversal from 11 consecutive quarters of relatively healthy growth.
Analysts recommend taking that forecast with a grain of salt, as it reflects a surge in imports that could result from firms frontrunning tariff risk. However, fears of an economic slowdown persist.
In a Thursday note to clients, Wells Fargo economists suggested the recent import surge could translate to a drag of 3-5 percentage points on GDP growth. However, they added that “it is early days. To the extent the surge in imports was a pull forward in demand in preparation for tariffs, we may see some payback in the coming months.”
Meanwhile, the Personal Consumption Expenditures Price Index (the Fed’s preferred measure) showed that inflation came in at 2.6% in January after factoring out volatile food and energy costs, while the Fed’s target is 2.0% inflation over the long term. Inflation in January was significantly lower than its peak near 6% in 2022, but progress has stalled.
PCE Price Index vs. Core PCE Price Index
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The Fed’s Stagflation Dilemma
Stagflation would be problematic for consumers and businesses, but it would put the Fed in an especially tight spot. A slowing economy needs a boost from lower interest rates, but with inflation still sticky, central bankers will hesitate to ease policy. Lower interest rates can stoke inflation. “It creates a huge dilemma for the Fed,” says Rose.
If stagflation emerges, Daco believes the Fed will lean toward leaving rates unchanged. With rate cuts currently on pause, he says it’s unlikely the central bank will want to risk having inflation expectations come de-anchored if they cut too soon, before economic data shows changes in price pressures. “They’re likely to wait for the data to be visible,” he says.
For Rose, the condition of the labor market could be a key factor. “If the labor market gets weak enough, I think the Fed will cut, even if tariffs are pushing up inflation today,” he says.
Some economists have argued that tariffs are a one-time shock, and that inflation’s effects over the years will be more muted. “When I think of stagflation, I think of sustained high inflation,” says Bill Adams, chief economist at Comerica Bank. “Unless tariff rates keep rising, I don’t see how tariffs would drive that sustained faster rate of price increases.”
Will Stagflation Happen?
Analysts say that while the threat of a stagflationary shock is higher than a few years or even a few months ago, it’s far from a foregone conclusion. There are still signs of strength in the US economy, and pundits have issued plenty of warnings about stagflation that didn’t materialize. “The boy has cried wolf many times,” says Adams. “Not to say that we couldn’t have a wolf, but I think the bar of evidence should be pretty high.”
Faucher says the risk of stagflation has grown. However, “I would still put that risk as pretty low … I don’t see any fundamental weaknesses in the economy that are signaling a problem yet.“ Productivity and demand are strong, and the labor market is holding up. Inflation is elevated but not alarmingly high by historical standards. Consumers are still spending, despite sentiment data that might suggest otherwise.
“We’re not in stagflation right now, and we haven’t been,” says Daco. “Today and over the past two years, we’ve had an exceptionally strong economy that has been disinflationary.” He points to how the economy has grown at about 3% per year for the past two years, while inflation has come down significantly. “That is the opposite of stagflation.”
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