Fed minutes highlight stagflation risks for the US economy

11 Apr 2025 , 11:25 AM

FOMC MEMBERS RED FLAG STAGFLATION RISKS FOR US ECONOMY

The minutes of the FOMC meeting conducted on March 18-19 was published by the Fed on April 09, 2025. One highlight of the Fed minutes was the majority of FOMC members red flagging stagflation risk for the US economy. Stagflation is where growth continues to be tepid, unemployment is inching up, but inflation is surging too. The spike in inflation is likely to come from the steeply higher tariffs that Trump has imposed on imports into the US. Trump has argued that low entry tariffs had made Americans overly dependent on imports.

The downside risk to such a situation is that any hike in tariffs can be steeply inflationary. However, late on April 09, 2025; Trump announced a pause on tariffs imposition for 90 days. Clearly, pressure was mounting on Trump, although the view is that some damage may have been done. The FOMC meeting happened in mid-March; much before the decision to pause on tariffs for 90 days. Hence, most arguments by FOMC are independent of this shift. The markets would have preferred a longer pause on tariffs than just 90 days.

WHAT WE READ FROM THE MINUTES OF THE FOMC MAR-25 MEET?

Here are some key inferences that we drew from a reading of the Fed minutes published on April 09, 2025.

• The gist of the minutes was the all round concern that Trump’s economic policies could push the US economy towards stagflation. That would imply a situation where GDP growth turns tepid, unemployment rises closer to 4.5% and inflation is back above 3%. In fact, the inflation impact is expected to manifest much sooner.
• Some FOMC members have warned of very difficult policy trade-offs for the US Fed if inflation proved persistent. It could worsen, if the outlook for GDP growth and employment also weakened in tandem. This could put the entire inflation control measures since 2022 and the growth resilience at risk.
• Fed chair, Jerome Powell, also commented that the tariffs imposed by Trump on imports from various countries were “significantly larger” than expected. He underlined that unless these tariffs were permanently reversed, the negative impact on inflation and GDP growth could also be larger than anticipated.
• The FOMC members have pointed to the sharp spike in the 10-year bond yields in the US, which crossed 4.5% after the last round of tariffs. FOMC members have warned that if the bond yields surged above 5%, it could be a situation of panic in the bond markets as it would result in a sharp depreciation in global bond portfolios.
• In the March FOMC meeting, as a precautionary measure, Fed slowed monthly run-off in government debt securities from $25 billion to $5 billion to ensure sufficient liquidity. However, several members were averse to this move (governor Waller dissented) since they wanted the Fed must focus on lightening the balance sheet deeper and quicker.
• The consensus decision in the meeting was to keep Fed rates in the range of 4.25% to 4.50% for longer so that the central bank has options left in its arsenal, should the inflation spike and growth and employment were to slow down. Members were almost unanimous that uncertainty about outcomes had substantially increased.
• An interesting observation made by the members of the FOMC was that the Trump tariffs had resulted in an abrupt repricing of risk in the financial markets; including risks to inflation, growth, and jobs. These could sharply exacerbate the effects of any negative shocks to the economy, warned the FOMC members.

Let us turn to what the CME Fedwatch says about rate trajectory.

CME FEDWATCH HINTS AT 1 RATE CUT EACH IN 2025 AND 2026

The CME Fedwatch is based on implied probabilities of Fed Futures trading.

Fed Meet	200-225	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450
May-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	19.0%	81.0%
Jun-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	12.6%	60.1%	27.4%
Jul-25	Nil	Nil	Nil	Nil	Nil	Nil	8.8%	45.9%	37.1%	8.1%
Sep-25	Nil	Nil	Nil	Nil	Nil	6.1%	34.5%	39.8%	17.0%	2.5%
Oct-25	Nil	Nil	Nil	Nil	2.4%	18.2%	37.2%	30.1%	10.6%	1.4%
Dec-25	Nil	Nil	Nil	1.3%	10.9%	28.5%	33.4%	19.6%	5.6%	0.6%
Jun-26	0.1%	0.6%	3.5%	11.3%	22.6%	28.2%	21.5%	9.7%	2.3%	0.2%
Dec-26	0.7%	2.8%	8.8%	18.2%	25.2%	23.2%	14.1%	5.5%	1.3%	0.2%

Data source: CME Fedwatch

We now have CME Fedwatch expectations till December 2026 and here is the gist.

• As of June 2025, CME Fedwatch is assigning 72.7% probability of 25 bps rate cut from the current level of (4.25%-4.50%).
• By December 2025, CME Fedwatch is assigning 74.2% probability to 3 rate cuts of total 75 bps from the current level. That looks the most likely scenario.

Amidst the macroeconomic uncertainty, we are not giving too much credence to the probabilities of 2026, as they could undergo drastic changes. However, by end of December 2026, there is 78.9% probability of 100 bps lower from current levels. That means, rate cuts are likely to be front-loaded in 2025 with limited change in 2026. Not surprisingly, the RBI appears to be comfortable cutting rates, as it did, once again, in its April 2025 policy.