Fed braces for impact as ‘stagflation 2025’ fears grow

Something doesn’t quite add up.

Inflation’s cooling, jobs are still growing, and yet the world’s most powerful central bank is looking increasingly uneasy. The Fed hasn’t resumed rate cuts, market jitters are rising, and suddenly, the word stagflation - that nasty blend of rising prices and slowing growth - is creeping back into the conversation.

It’s not 1970, but it’s starting to feel uncomfortably familiar. With warning signs flashing from GDP to the jobs market, and tariffs quietly stirring up inflation pressure behind the scenes, the Fed looks less like it’s managing a soft landing - and more like it’s bracing for a bumpy one.

Let’s unpack what’s really going on.

Stagflation risk is mounting

In May 2025, 14 FOMC members flagged upside risks to both inflation and unemployment - a rare and worrying alignment. Not one projected a meaningful decline in either. This pattern was also seen in March 2025, December 2024, and September 2024.

This is more than just cautious forecasting - it’s the kind of dual risk signal last seen during the stagflation era of the 1970s, when soaring prices and sluggish growth left policymakers in a no-win situation.

So far, Jerome Powell has resisted cutting rates, despite cooling CPI numbers, and now we can see why. He’s not just looking at what inflation is today, but what it could become if tariffs squeeze supply chains and cost pressures get passed on.

GDP contraction and jobs tell a split story

At first glance, the economy doesn’t look too bad. The May jobs report showed 139,000 new jobs, a touch better than expected. But the details matter - especially the 95,000 downward revision to previous months and early signs of rising layoffs in key sectors.

The labour market might still be moving, but it’s losing momentum.

And then there’s growth. The U.S. economy contracted by 0.2% in Q1 - the first negative GDP print in over two years. The headline number was hit by a historic import surge, creating the largest trade drag in nearly 80 years. But strip away the noise, and core GDP -measured by final sales to private domestic buyers- tells an even starker story: a drop from 2.5% in Q1 to an expected -1.0% in Q2.

That’s not just a slowdown, it’s a stall.

Inflation is cooling… but only just

On the surface, inflation looks tame. Headline CPI came in at 2.35% year-on-year in May, below the Fed’s 2.5% comfort zone. Core inflation has hovered near 2% for three straight months.

So why isn’t the Fed relaxing?

Nomura economists point out that real inflation pressure is still in the pipeline. Survey data shows that nearly a third of manufacturers and 45% of service firms plan to fully pass on tariff-related costs to consumers. So far, elevated inventories have masked these price hikes, but once those buffers run out, we may see inflation creep back up right when growth is already fading.

US Dollar weakness when it should be strengthening

Here’s where things get stranger. In theory, stagflation, with sticky inflation and a hawkish Fed, should strengthen the U.S. dollar. And yet, 2025 has been brutal for the greenback.

The U.S. Dollar Index (DXY) is down 10.8% so far this year - the worst first-half performance since 1973, when Bretton Woods collapsed. The Bloomberg Dollar Spot Index has declined for six straight months, matching its longest losing streak in eight years.

This isn’t just a weak dollar story - it’s a confidence story. The market is reacting to mounting deficit spending, tariff shocks, and the growing belief that the Fed will eventually cave and cut rates, even if inflation isn’t fully tamed.

Policy paralysis and the 1970s trap

The Fed’s current dilemma has all the hallmarks of a policy trap. Cut rates now, and you risk igniting inflation all over again - a mistake the central bank made repeatedly in the 1970s. Hold rates too high for too long, and you deepen the downturn.

Meanwhile, fiscal policy is boxed in. The Trump administration just passed a “big, beautiful budget bill” that adds trillions in spending, further ballooning the national debt.

Some argue this might be a strategic currency weakening to reduce the real debt burden. As noted by the National Bureau of Economic Research, a 10% drop in the dollar could shave $3.3 trillion off the U.S. debt. But push that too far, and you risk undermining the dollar’s global reserve status - the very thing keeping the U.S. economy afloat.

Technical outlook: Is stagflation coming?

We’re not in full-blown stagflation - not yet. But the foundations are starting to crack. Growth is faltering, inflation pressures are reloading, policy tools are limited, and the Fed, clearly, is on edge.

Markets may be banking on a soft landing. The Fed, meanwhile, looks like it’s preparing for something harder and bumpier. A stagflation situation would likely support the dollar and lead to it strengthening over the Euro, toppling the current state of affairs. 

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.  

Will the dollar strengthen over the Euro as stagflation fears grow? Speculate on the price trajectory of the EURUSD pair with a Deriv MT5, Deriv cTrader, or a Deriv X account.