The specter of stagflation – that unwelcome mix of high inflation and stagnant economic growth – is increasingly on the minds of Federal Reserve officials, driven significantly by concerns over the impact of tariffs.
During his recent press conference following the Fed’s latest policy meeting, Chair Jerome Powell repeatedly highlighted the potential inflationary pressures stemming from imposed duties. “Everyone that I know is forecasting a meaningful increase in inflation in coming months from tariffs because someone has to pay for the tariffs,” Powell stated, acknowledging that some of the burden will ultimately fall on American consumers.
While recent U.S. economic data has painted a relatively positive picture – including solid job growth (139,000 added in May) and stable unemployment (4.2%), alongside improved consumer sentiment and a modest May CPI increase of just 0.1% – these figures may not yet reflect the full effect of tariffs.
The Lag Effect of Tariffs
Powell explained that the impact of tariffs works through the economy with a delay. Goods currently being sold by retailers may have been imported months ago, before the tariffs were in place. This suggests that while the immediate data looks stable, more significant price effects are anticipated in the coming months as higher-cost imported goods filter through supply chains to the final consumer.
Forecasts Signal Rising Stagflation Risk
The Federal Reserve’s own updated economic projections released this week underscore the rising risk. The forecast for Gross Domestic Product (GDP) growth in 2025 was lowered by 0.3 percentage points to 1.4%. Simultaneously, the projection for inflation, measured by the personal consumption expenditures (PCE) index, was raised by 0.3 percentage points to 3% for 2025 (with core PCE forecast at 3.1%).
This combination of slower expected growth and higher expected inflation explicitly points to early signs of potential stagflation. The unemployment outlook also saw a slight upward revision to 4.5%.
Though Fed officials currently “don’t see signs” of an immediate weakening in the U.S. economy, Powell acknowledged that growth will “eventually” slow. This cautious outlook, coupled with the revised forecasts, confirms that stagflation is a distinct possibility the central bank is contemplating for the months ahead.
Interest Rates Held Steady Amidst Uncertainty
Amidst this uncertain economic landscape, the Federal Reserve’s Federal Open Market Committee (FOMC) opted to keep its benchmark interest rate steady in the target range of 4.25%-4.5%, where it has been since December.
While the rate was held, the committee’s closely watched “dot plot,” which reflects individual members’ rate expectations, still indicated two potential interest rate reductions before the end of 2025. However, the projections also revealed growing divergence among officials, with a notable increase in the number of participants now preferring no rate cuts this year. Despite this dispersion in outlook, the official policy statement was approved unanimously.
Fed Chair Powell reiterated a patient approach, stating the central bank is “well positioned to wait to learn more about the likely course of the economy before considering any adjustments.” This patient stance is partly influenced by the uncertainty surrounding tariffs and their future inflationary impact, alongside other potential wild cards like geopolitical risks (such as the conflict between Israel and Iran) and domestic political pressure for lower rates.
Impact on Consumers: Borrowing Costs Remain High
The decision to hold interest rates steady has tangible implications for consumers’ wallets. While the federal funds rate doesn’t directly set consumer rates, it heavily influences them. Despite previous rate cuts in 2024, borrowing costs across the board remain elevated.
Credit Cards: Many credit cards have variable rates tied to the Fed’s benchmark. The average credit card annual percentage rate (APR) remains over 20%, near recent all-time highs, as banks largely maintain rates. Even significant future Fed cuts may only marginally lower these rates.
Auto Loans: Auto loan rates are also significantly influenced by the Fed. Average rates for new car loans are near record highs (around 7.3% for a 5-year loan in May), compounded by rising car prices. This has led to a growing affordability crisis, with a significant portion of households paying over $1,000 per month for car payments.
Mortgages: Mortgage rates, while not directly tied to the Fed’s rate, are linked to Treasury yields and broader economic sentiment. Concerns over tariffs and uncertainty have kept rates relatively stable but elevated, with 30-year fixed mortgages hovering near 7%. Adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) remain higher as well.
Savings: On the flip side, savers continue to find attractive opportunities. Top-yielding online savings accounts are still offering yields over 4%, comfortably outpacing recent inflation and providing a favorable return for depositors.
Global Markets React
Global markets showed mixed reactions to the Fed’s decision and the broader economic outlook. US stocks traded near the flatline following the announcement. European and Asian markets generally saw declines, with investors weighing the Fed’s cautious stance, the ongoing trade policy uncertainty, and geopolitical risks. Currency markets also saw shifts, with some Southeast Asian currencies weakening against a strengthening U.S. dollar, while the Euro gained ground. Gold prices also showed strength, viewed by some analysts as a “clear beneficiary” of increased geopolitical uncertainty and institutional buying.
As the Fed navigates the complex interplay of potential tariff-fueled inflation, slowing growth signals, and external pressures, the possibility of stagflation remains a key focus, shaping both policy decisions and the economic outlook for the months ahead.
