J. Powell Charts the Way (To Stagflation. Worst-Case Scenario for Stocks)
“Without price stability, we cannot achieve long periods of strong labor market conditions.”
— Federal Reserve Chair Jerome Powell
Summary
Federal Reserve Chair Jerome Powell has now openly acknowledged that recent trade policy shifts are likely to move the U.S. economy further away from the Fed’s dual mandate. His comments this week confirmed a core thesis we've laid out in recent weeks: stagflation is taking shape, and the Fed is signaling that fighting inflation will take precedence over preserving employment.
This sets up a worst-case scenario for equities – with falling earnings and a policy path locked into higher-for-longer rates.
Key Points
- Recent tariffs risk triggering both inflation and higher unemployment, the textbook definition of stagflation.
- The Fed’s dual mandate (price stability and full employment) is inherently compromised under stagflation.
- In such a conflict, Powell has made clear: fighting inflation takes priority.
- The Fed is now concerned about temporary price shocks becoming embedded in long-term inflation expectations, which could force prolonged tightening.
- For equities, this is the most hostile environment: slower growth, falling margins, and no relief from rates.
What Did Jerome Powell Say?
Speaking at a closed-door policy event and as reported by the Financial Times, Powell acknowledged that:
“The administration is implementing significant policy changes and particularly trade is now the focus. The effects of that are likely to move us away from our goals.”
This is a direct acknowledgment that the Fed sees growing tension between its dual mandate. For context, core PCE inflation stood at 2.8% in February vs. the Central Bank’s 2% target, while unemployment was at 4.2% in March, near the low end of the Congressional Budget Office’s estimated NAIRU (non-accelerating inflation rate of unemployment) range of 4% to 5% but ticking higher.
It’s important to note that unemployment is a lagging indicator, often reacting with a 3- to 4-month delay to changes in GDP growth. This means that even if the economy is already slowing due to higher rates, tightening credit, or tariff-driven disruptions, the labor market may not reflect that reality until early summer. Powell’s framing suggests that the Fed is anticipating a deterioration in employment conditions but will continue to prioritize inflation control.
He then said:
“Without price stability, we cannot achieve long periods of strong labor market conditions.”
This statement further reinforces the Fed’s hierarchy: inflation comes first. If controlling inflation requires tighter policy even in the face of rising unemployment, Powell appears prepared to accept that trade-off.
Powell also commented that:
“The president’s tariffs announced so far had been significantly larger than anticipated... the same was likely to be true of the economic effects, which will include higher inflation and slower growth.”
This is a striking shift in tone. Just last month, in its March 2025 Summary of Economic Projections, the Fed Board of Governors forecasted:
- Two 25 bps rate cuts by year-end (albeit a significant minority supported more hawkish policy)
- Core PCE inflation at 2.7%–2.8%
- GDP growth at 1.7%
- Unemployment at 4.4% by December
Now, Powell is clearly acknowledging that the tariffs were larger than the Fed expected, and their inflationary and recessionary effects (higher prices, weaker output) are likely to be underestimated in current models.
The next FOMC meeting (May 6–7) may not include fresh projections, but Powell’s press conference on May 7 (2:00 PM ET) will be closely watched for confirmation of whether the Fed’s internal tone has turned more hawkish considering recent policy shifts.
Investment Strategy Implications
If Powell is indeed preparing to accept higher unemployment in exchange for price stability, then rate cuts are off the table for the foreseeable future. The odds are increasing that the Fed will hold, or even re-tighten, policy despite weaker growth or rising credit stress. This is toxic for stocks, especially in cyclical and interest-rate sensitive sectors.
We maintain our recommendation to rotate into cash and prioritize high-dividend domestic names, particularly in defensive services (e.g., property & casualty insurance, healthcare admin, and utilities), avoiding cyclicals and rate-sensitive industries as well as names trading in imported goods.
