The Fed is sweating, even if the data says it shouldn’t be.
Inflation’s cooling. Jobs are holding up. Financial markets are marching on. But beneath the surface, the signals are turning
messy, and the world’s most influential central bank seems to know it. Jerome Powell hasn’t touched rates in months, not because the coast is clear, but because the storm might still be brewing.
Whispers of stagflation, that dreaded mix of rising prices and sluggish growth, are getting louder. And this time, it’s not
just market pundits stirring the pot. The Fed’s own members are ringing the alarm.
A rare red flag from inside the fed
Here’s something you don’t see every day: In May, 14 FOMC members flagged upside risks to both inflation and unemployment.
Source: Federal Reserve Board, Bloomberg, Kobeissi Letter, Apollo
That’s a rare double warning – and it hasn’t shown up this clearly since the 1970s.
Source: BEA, BLS
Source: BEA, BLS
Even more telling? Not one policymaker saw a path where either inflation or unemployment might fall. That’s not just cautious
– it’s an outright red flag. A soft landing might be the headline, but behind the scenes, the Fed is bracing for impact.
Growth slips while jobs wobble
Let’s talk numbers. U.S. GDP shrank by 0.2% in Q1 2025 – the first contraction in over two years. The culprit? An enormous
surge in imports, dragging the trade balance to its worst place in nearly 80 years of GDP records.
But look a little deeper. Core domestic demand – measured by final sales to private domestic purchasers – is expected to
plunge from +2.5% in Q1 to -1.0% in Q2. That’s not a gentle slowdown. That’s a jolt.
Meanwhile, the labour market is still adding jobs, 139,000 in May, to be exact, but it’s hardly smooth sailing. 95,000 jobs
were quietly erased from prior months in revisions, and new cracks are forming beneath the surface. Layoffs are creeping up, especially in industries sensitive to tariffs and rates.
Source: US Bureau of Labor Statistics
Inflation looks fine… until it doesn’t
On paper, inflation is under control. Headline CPI sits at 2.35%, just below the Fed’s comfort zone. Core inflation has tracked
neatly around 2% over the last few months. Nothing to panic about, right?
Source: Ycharts
Maybe. But
Nomura’s
economists think this is the calm before the storm.
Tariff-related cost pressures are building. According to surveys, a third of manufacturers and nearly half of service firms
plan to fully pass those costs on to consumers. So far, elevated inventories have masked the blow. But once those shelves empty, prices could snap higher, just as growth is fading.
The dollar dilemma
Now here’s the twist: stagflation typically sends the U.S. dollar soaring, as investors seek refuge in a currency backed
by stability and higher rates. Not this time.
In the first half of 2025, the U.S. Dollar Index (DXY) plunged 10.8% — its worst start to a year since 1973, when the gold
standard collapsed. It’s also the sixth straight monthly drop for the Bloomberg Dollar Spot Index, matching an eight-year losing streak.
The message? Markets aren’t convinced the Fed will stick to its guns. With record deficit spending, a looming credit downgrade,
and pressure to pivot, the dollar’s safe-haven status is slipping fast.
Trapped Between Policy Tools
What’s really worrying is the lack of room to manoeuvre.
The Fed can’t cut rates without risking a return of inflation. But keeping rates high could drive the economy into recession.
It’s the classic stagflation trap – and this time, there’s a new twist: fiscal policy is out of ammo too.
Trump’s administration just passed a multi-trillion-dollar budget bill, adding to a ballooning deficit already under scrutiny
from credit agencies. Some economists argue this might be a deliberate push to weaken the dollar and lighten the real debt load. But if the slide continues unchecked, the U.S. could jeopardise the very thing that keeps it afloat – the dollar’s reserve currency
status.
Technical outlook
This isn’t panic stations – not yet. But it’s starting to smell like trouble.
Growth is slowing. Inflation might be reloading. The labour market is softening. And the Fed? It’s gone quiet – not because
it’s calm, but because it’s watching something it doesn’t quite know how to stop.
Whether this turns into a full-blown stagflation storm or just another policy scare depends on what comes next – tariffs,
inventories, wages, oil prices, and how long Powell can hold the line.
One thing’s clear: the Fed may be bracing for impact… and maybe the rest of us should too.
At the time of writing, the EURUSD pair is still on an upward trajectory, though sellers are evidently having their say on
the daily chart. Volume bars show that sellers are pushing back strongly against recent buy pressure, hinting that we could see a significant drawdown.
Should prices inch lower significantly, sellers could find support at the 1.1452 and 1.1229 price levels. Conversely, if we
see an uptick, buyers could encounter resistance at the 1.1832 price level.
Source: Deriv MT5
Disclaimer
The information contained within this article is for educational purposes only and is not intended as financial
or investment advice. We recommend you do your own research before making any trading decisions.
This information is considered accurate and correct at the date of publication. Changes in circumstances
after the time of publication may impact the accuracy of the information.
The performance figures quoted are not a guarantee of future performance.
