Stock market resilience amidst disappointing economic indicators and recession apprehensions
The US economy is currently in a precarious position, with signs of rising inflation and a slowdown in economic growth, but not yet fully entering a stagflation phase. This assessment is based on a variety of key economic indicators.
Inflation Remains Above Target
Inflation remains above the Federal Reserve's target, with the Consumer Price Index at about 2.7% in June 2025 and core inflation near 2.9%. This level is sticky and expected to persist for some time, higher than the Fed’s 2% goal.
Mixed Economic Growth
Economic growth is mixed but not fully stagnant. GDP contracted slightly (-0.5%) in Q1 2025 but rebounded about 3% in Q2, driven mainly by investments like AI data centers. However, this growth's sustainability is uncertain, with some signs of slowing imports and overall economic momentum.
Low Unemployment Rate
Unemployment remains relatively low at 4.2%, unlike the stagflation of the late 1970s and early 1980s. The labor market is still relatively healthy, which is why many economists hesitate to declare the US in stagflation yet.
Risks of Stagflation Increasing
Despite these positive signs, risks for stagflation are increasing. Economists are wary of a mix of inflationary pressures, tariffs, labor shortages, and Federal Reserve constraints, potentially trapping the Fed between lowering interest rates to stimulate growth and raising them to control inflation. Political and policy uncertainty, such as trade tariffs and immigration policy, also contribute to economic challenges that could fuel stagflation if unresolved.
Market Responses and Political Interventions
The stock market has shown resilience despite these economic uncertainties. The Nasdaq has surged 20% since May, while the S&P 500 has jumped 13% and the Dow has climbed 7% over that period. However, President Donald Trump has claimed without evidence that the jobs data had been "manipulated."
In a social media post, Trump touted his economic performance: "The Economy is BOOMING under 'TRUMP' despite a Fed that also plays games, this time with Interest Rates." Trump also fired the head of labor statistics, Erika McEntarfer, who was an appointee of former President Joe Biden.
Potential Stagflation and the Fed
If inflation stays high and economic growth continues to slow without improvements in employment, the risk of stagflation will increase further, posing significant challenges to policymakers and markets. Potential stagflation poses difficulty for the Fed, as raising interest rates to protect against tariff-induced inflation could stifle borrowing and slow the economy further.
On the other hand, if the Fed lowers rates to stimulate the economy in the face of a potential slowdown, it threatens to boost spending and worsen inflation. For now, the major stock indexes have largely recovered from the marked falls experienced last Friday.
Employment and Consumer Spending
Employers are hiring at their slowest pace since 2020, according to the U.S. Bureau of Labor Statistics data. Despite this, consumer spending, which accounts for about two-thirds of economic activity, ticked higher over the three months ending in June.
In conclusion, the US economy is flirting with stagflation—exhibiting some symptoms like persistent inflation and uneven growth—but has not yet reached the full stagflation condition because unemployment is still moderate and growth, while fragile, has not collapsed. The Fed and policymakers will need to navigate this delicate balance carefully to avoid a potential stagflation scenario. For now, markets remain opportunistic about current gains, rather than wary of possible headwinds that may emerge in the coming weeks or months.
- The Fed faces a challenge in navigating the rising risks of stagflation, as keeping interest rates low to stimulate growth could exacerbate inflation, while raising them might slow the economy further.
- International economies are paying close attention to the US economy's precarious position, given that economic growth, while still positive, has shown signs of slowing and is largely dependent on investments like AI data centers.
- In light of the potential stagflation scenario, investors may want to consider diversifying their portfolio, including exploring international businesses and stocks that could prove more resilient in such an economic environment.
- As the US economy grapples with persistent inflation, slowing growth, and the uncertainty of ongoing political and trade policies, travel plans may become a luxury for some, as people adapt to potential fluctuations in the value of their money due to inflationary pressures.