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20 March 2025 - 1:00pm
On Wednesday the US Federal Reserve Board announced that it would hold interest rates, with a target in the range of 4.25-4.5%. Though the Fed expects to cut rates another couple of times in 2025, it also noted that America’s outlook has changed — which is bound to complicate the path ahead.
By predicting slower growth than previously expected, but higher inflation, central bankers are warning that the economy could slide into stagflation. That, as it happens, is the view of an increasing number of economists, who believe that the Trump administration’s volatile policymaking and use of tariffs could damage the American economy.
Of course, this very volatility makes forecasting even more difficult, but for now the Fed seems willing to give the administration the benefit of the doubt. At the press conference following the meeting, Chairman Jerome Powell was goaded by journalists into saying that the inflationary impact of tariffs could prove transitory — that dreaded word which hasn’t aged terribly well, since it’s also what he said about pandemic inflation.
But given this appearance of equanimity, investors interpreted the announcement as dovish, driving up prices of both stocks and bonds — the effect of the latter being to reduce interest rates on long-term debt. This reaction was a bit puzzling. For bonds and stocks to rally simultaneously in the absence of a clear sign of policy loosening is unusual. The former would suggest bond investors foresee a recession, and thus a fall in inflation; the latter suggests stock investors foresee a resumption of growth. Given that US stocks remained priced for close to perfection, with expectations of earnings presuming continued strong economic growth, one of these narratives will have to give before long.
This is because the Fed did not in fact signal an imminent loosening of monetary policy. On the contrary, the dot plot of the expected rate decisions of individual governors revealed that, if anything, the central bank has become more concerned with inflation, and may be more likely to tighten — rather than loosen — policy in the months ahead.
Although inflation has yet to turn upwards significantly, core inflation has not returned to the Fed’s target range and doesn’t look likely to do so anytime soon. Meanwhile, consumer and business surveys reveal expectations of sharply higher inflation in the months and years ahead. At the moment, a slowing economy is keeping the job market weak, so workers have been reluctant to demand pay increases. But given that labour-supply growth is slowing, due to Donald Trump’s tightening of immigration controls, any economic upturn will almost certainly result in wage inflation.
In the coming months, one of two things is therefore likely to happen. Either the economy picks up speed, raising inflation with it; or it loses speed, knocking down share prices. It’s quite possible, too, that not all Fed governors share Powell’s belief that tariffs will have only a passing inflationary impact. Indeed, given the Fed Chair’s patchy record of prognostication on this topic, caution would be advised. Inflation may yet rise as growth slows, which would be bad for both stocks and bonds.
In short, this rally may have legs, but it would take a brave soul to assume the bear market in US stocks isn’t happening soon. Anybody looking to buy into the rally should bear in mind a well-honed piece of financial advice: caveat emptor.
John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a Religion (Simon & Schuster, 2017).
jarapley