Nick Timiraos wrote that the historical mirror of stagflation in the 1970s no longer seems as distant as it was two years ago. The Federal Reserve's April meeting marks a pivotal point in a deeper debate: how long can the committee maintain its stance that 'the next move is more likely to be a rate cut rather than a rate hike'? Should the formal statement wording be revised to indicate that a rate cut is essentially off the table?
Nick Timiraos, a well-known financial journalist often referred to as the 'new Fedwire,' wrote ahead of the Fed's April FOMC meeting that:
Two years ago, when the U.S. economy was running smoothly and inflation continued to recede, Federal Reserve Chair Powell humorously responded to external concerns about 'stagflation': 'Frankly, I see neither stagnation nor inflation.'
Today, an energy shock triggered by an actual war has once again brought this risk to the forefront — at a time when inflation in the U.S. economy has never truly returned to the Fed's 2% target. The historical mirror of the 1970s stagflation no longer seems as distant as it did two years ago.
Stagflation refers to the dilemma of stagnant economic growth coexisting with high inflation. Last year, the topic resurfaced as tariff policy threats pushed up prices and suppressed employment. However, at that time, it remained theoretical, with policy adjustments readily available to correct course.
Timiraos pointed out that it is almost certain that Fed officials will keep the benchmark interest rate unchanged in the range of 3.5% to 3.75% at the two-day meeting concluding this Wednesday. However, this meeting — also the last before Powell's term ends — marks a turning point in a deeper debate: How long can the committee maintain its stance that the next move is more likely to be a rate cut rather than a hike?
Fed officials are closely observing how the U.S. economy absorbs a fourth supply shock in five years: the pandemic restart, the Russia-Ukraine conflict, tariff disputes, and the Iran war. Each shock could be interpreted as an isolated event not requiring policy intervention. However, the cumulative effect has left officials walking on thin ice. Tariffs are testing businesses' and consumers' tolerance for price increases.
In his article, Timiraos noted that Fed policymakers are grappling with another question: Is sluggish job growth overstating the fragility of the labor market? If slower immigration means the economy no longer requires as many new jobs as before, then reduced employment growth might not signal a true recession.
Fed Governor Waller, who previously supported three rate cuts last year due to concerns about the U.S. labor market, has now shifted his focus to guarding against inflation. He cited the 1970s history — when officials repeatedly dismissed shocks as 'temporary' and failed to respond, allowing inflation expectations to drift away from their anchor. Waller said:
We must remain vigilant about this series of isolated shocks. Expectations matter, and at some critical point, you may have no choice but to act.
We've been saying the target is 2%. Five years have passed, and inflation has never truly returned to that level. At what point will people start questioning your commitment?
Despite the announced ceasefire in the Iran war, the Strait of Hormuz remains effectively blockaded. Jet fuel prices have surged. Federal Reserve officials now anticipate that the process of inflation returning to the 2% target will stall for another full year.
Some Federal Reserve officials had previously discussed restoring interest rate cuts this year to offset the effects of 'automatic tightening amid falling inflation and unchanged interest rates.' That argument is now a thing of the past. New York Fed President Williams stated earlier this month:
Given the current situation, that scenario simply does not exist. If there is any movement in inflation, it is trending upward.
Williams characterized the Fed's current stance as an active choice rather than passive adherence: Our monetary policy is clearly in the right place, and this is exactly where we want to be.
Timiraos pointed out that compared to the 1970s, the U.S. economy has undergone profound changes today, making a complete repeat unlikely. Moreover, the Fed today places far greater emphasis on managing inflation expectations than it did back then.
For members of the Fed’s FOMC committee, Timiraos noted that the bigger question is whether formal statement language should be revised to signal that rate cuts are largely off the table. History shows that the impact of such wording adjustments can sometimes rival that of interest rate decisions themselves.
Since the end of last year, the Fed’s statements have consistently included a nine-word phrase suggesting that the next policy move would more likely be a rate cut than a hike. At the most recent two meetings, a minority of officials advocated removing this language—once removed, it would imply that rate cuts and hikes are seen as equally possible.
The rationale for those advocating removal is that inflation trends are moving in the opposite direction, and under successive shocks, predicting when inflation will return to 2% has become increasingly difficult; the labor market remains robust, and stock prices have rebounded to historic highs. All of this is inconsistent with a committee still signaling impending rate cuts.
However, the prevailing view within the committee is that this change would be too drastic. Modifying the formal wording itself would tighten financial conditions, constituting a hawkish move that officials may not yet be ready to take. Williams, an ally of Powell, stated, 'We are not in a position to issue strong forward guidance at this time, nor are we doing so.'
Fed officials will review this issue again this week.
Timiraos noted that the thinking of the Fed's FOMC committee sometimes moves faster than its words. Before resorting to formal statement language as the 'heavy hammer,' officials have other more circuitous ways to convey policy direction—whether through Powell’s press conference on Wednesday, official speeches in May, or the economic forecasts released at the next meeting in mid-June.
Timiraos concluded that by then, the leadership of the Fed’s FOMC committee may well have shifted to Kevin Warsh—the former Fed governor nominated by Trump, succeeding Powell. The decision on whether and how to formally adjust the Fed’s policy guidance might fall to Warsh, and his judgment on this matter could differ significantly from that of his predecessor.
Editor/Rocky