Mid-Year Outlook: At the Crossroads of Stagflation—What’s Next?

Key Takeaways

• While below initial expectations, this is still the highest level of tariffs the US has had in nearly nine decades and, if kept, will have substantial impact on the US and global economies.
• Tariff hikes are typically stagflationary shocks—they simultaneously increase the probability of an economic slowdown while putting upward pressure on prices. In our view, the current tariff regime increases the chance of a US recession to 25% over the next 12 months.
• As a result, we continue to expect interest rates higher for longer. As of this writing, we see the Federal Reserve cutting rates only once in 2025, with a year-end fed funds-rate target range of 4.00% to 4.25%. We believe that Fed Chairman Jerome Powell will likely take a conservative approach to easing policy to safeguard against fears of runaway inflation.
• Economic data have mirrored the volatility in the markets and trade policy. Soft indicators (e.g., confidence surveys) have fluctuated in tandem with news of on-again, off-again tariffs, while hard data (i.e., employment and inflation) have shown more resilience. This discrepancy has added to uncertainty and continues to fog the economic outlook.