Stagflation Puts Fed in Tricky Spot    03/17 06:11

   As the Fed prepares to meet Tuesday and Wednesday, the central bank and its 
chair, Jerome Powell, are potentially headed to a much tougher spot. Inflation 
improved last month but is still high and tariffs could push it higher. At the 
same time, ongoing tariff threats as well as sharp cuts to government spending 
and jobs have tanked consumer and business confidence, which could weigh on the 
economy and even push up unemployment.

   WASHINGTON (AP) -- When Federal Reserve officials last met in late January, 
things looked pretty good: Hiring was solid. The economy had just grown at a 
solid pace in last year's final quarter. And inflation, while stubborn, had 
fallen sharply from its peak more than two years ago.

   What a difference seven weeks makes.

   As the Fed prepares to meet Tuesday and Wednesday, the central bank and its 
chair, Jerome Powell, are potentially headed to a much tougher spot. Inflation 
improved last month but is still high and tariffs could push it higher. At the 
same time, ongoing tariff threats as well as sharp cuts to government spending 
and jobs have tanked consumer and business confidence, which could weigh on the 
economy and even push up unemployment.

   The toxic combination of still-high inflation and a weak or stagnant economy 
is often referred to as "stagflation," a term that haunts central bankers. It 
is what bedeviled the United States in the 1970s, when even deep recessions 
didn't kill inflation.

   Stagflation, should it emerge, is hard for the Fed because typically 
policymakers would lift rates -- or keep them high -- to combat inflation. Yet 
if unemployment also rises, the Fed would usually cut rates to reduce borrowing 
costs and lift growth.

   It's not yet clear the economy will sink into stagflation. For now, like 
businesses and consumers, the Fed is grappling with a huge amount of 
uncertainty surrounding the economic outlook. But even a mild version -- with 
the unemployment rising from its current low level of 4.1%, while inflation 
stayed stuck above the Fed's 2% target -- would pose a challenge for the 
central bank.

   "That's the tangled web they're in," said Esther George, former president of 
the Federal Reserve's Kansas City branch. "You have inflation stickiness on the 
one hand. At the same time, you're trying to look at what impact could this 
have on the job market, if growth begins to pull back. So it is a tough 
scenario for them for sure."

   Fed officials will almost certainly keep their key rate unchanged at their 
meeting this week. Once the meeting concludes Wednesday, they will release 
their latest quarterly economic projections, which will likely show they expect 
to cut their rate twice this year -- the same as they projected in December.

   The Fed implemented three cuts last year and then signaled at the January 
meeting that they were largely on pause until the economic outlook becomes 
clearer.

   Wall Street investors expect three rate reductions this year, in June, 
September, and December, according to futures prices tracked by CME Fedwatch, 
in part because they worry an economic slowdown will force more reductions.

   One development likely to unnerve Fed officials is the sharp jump in 
inflation expectations this month in the University of Michigan's consumer 
sentiment survey. It showed the biggest increase in long-term inflation 
expectations since 1993.

   Such expectations -- which basically measure whether Americans are worried 
inflation will get worse -- are important because they can become 
self-fulfilling. If businesses and consumers expect higher costs, they may take 
steps that push up inflation, like demanding higher wages, which in turn can 
force companies to raise prices to offset higher labor costs.

   Some economists caution that the University of Michigan's survey is 
preliminary and for now based on only about 400 responses. (The final version 
to be released later this month typically includes about 800.) And financial 
market measures of inflation expectations, based on bond prices, have actually 
declined in recent weeks.

   The most recent inflation readings have been mixed. The consumer price index 
dropped last week for the first time in five months to 2.8% from 3%, an 
encouraging change. But the Fed's preferred price gauge, to be released later 
this month, is likely to be unchanged.

   The jump in inflation expectations is also a problem for the Fed because 
officials, including Powell, have said they are willing to let inflation 
gradually return to their 2% target in 2027, because expectations have 
generally been low. If other measures show inflation worries rising, the Fed 
could come under more pressure to get inflation down more quickly.

   "I do worry when I see consumer expectations moving in the opposite 
direction," George said. "I think you just have to keep an eye on that."

   The last time President Donald Trump imposed tariffs -- in 2018 and 2019 -- 
overall inflation didn't rise by much, in part because they weren't nearly as 
broad as what he is currently proposing and some duties, such as those on steel 
and aluminum, were watered down with loopholes. Now that Americans have lived 
through a painful inflationary episode, they are likely to be more skittish 
about rising prices.

   Powell referred such concerns in remarks earlier this month. He said tariffs 
could just have a one-time impact on prices without causing ongoing inflation. 
But that could change "if it turns into a series" of tariff hikes, he said 
March 7, or "if the increases are larger, that would matter."

   "What really does matter is what is happening with long-term inflation 
expectations," Powell added.

   A week after his comments, those expectations shot higher in the University 
of Michigan survey.