Stagflation, the combination of high inflation and slowing economic growth, is once again raising concerns among investors. Not long ago, the narrative of the “exceptionality” of the American economy, supported by solid macroeconomic data and significant political events, was dominant. However, increasing signals are now suggesting that this optimism may be waning.
In recent weeks, analysts have focused on the relatively weaker performance of U.S. stock markets compared to European markets. The Dow Jones and S&P 500 have recorded the largest declines this year, and the ICE Dollar Index, which measures the value of the dollar against a basket of major currencies, has decreased by 1.7% since the beginning of the year. The drop in the value of the dollar could indicate growing caution among investors about the prospects for the U.S. economy, while seeing greater stability outside the United States.
Concerns are also rising in the bond market, where the yields on 2-year and 10-year U.S. Treasury bonds have fallen to the lowest levels of 2025. Typically, lower yields signal increased demand for bonds, suggesting a flight to safer assets in the face of an uncertain future. Such a situation often accompanies expectations of economic slowdown or even recession.
The main cause of the worsening sentiment remains inflation, which continues to stay above target. Despite earlier aggressive interest rate hikes by the Federal Reserve, the pace of inflation reduction remains unsatisfactory. Inflation expectations in the U.S. have already surpassed 3%, and the 5-year breakeven rate has reached 2.61%, the highest level in two years. These data suggest that market participants do not believe in a quick return of inflation to the 2% target, which could increase nervousness and lead to a sell-off of riskier assets such as stocks.
The upcoming weeks will be crucial for financial markets, mainly due to key macroeconomic publications. On Friday, the PCE report, a key inflation indicator for the Fed, will be released, with a projected increase of 0.3% month-over-month, potentially confirming the ongoing price pressure. Then, on March 7, labor market data will be published, followed by the CPI inflation reading on March 12. If inflation proves difficult to control, and there is also visible slowing in job creation and wage growth, the specter of stagflation will become more real.
For the Federal Reserve, this situation presents a serious challenge. Traditionally, the central bank combats high inflation by raising interest rates, but in a weakening growth environment, such actions could increase the risk of a recession. On the other hand, a too lenient approach to inflation could entrench it, potentially jeopardizing the stability of the economy in the long term.
If macroeconomic data fail to ease investor concerns, pessimistic sentiment could persist in the stock markets, and financial liquidity could further worsen. Fears of prolonged high interest rates and slowing growth may prompt large institutional investors to exercise even greater caution. In such conditions, safe assets such as government bonds or gold may gain in importance at the expense of the stock market.
If the U.S. economy indeed enters a phase of stagflation, a simultaneous battle against high inflation and slowing growth will be necessary. This would be an exceptionally difficult scenario for the Fed and financial market participants, requiring precise balancing of monetary policy and flexible responses to new data. As a result, investors are already preparing for increased volatility, expecting that the upcoming macroeconomic publications and Fed decisions will be crucial for the future direction of the market.
Krzysztof Kamiński – Oanda TMS
Source: ceo.com.pl
