Stagflation Clouds Fed Outlook as Tariffs and Geopolitics Stir Uncertainty

Economic

Summary:

Despite upbeat short-term data, the Federal Reserve remains concerned about stagflation risks, as inflation forecasts rise and economic growth slows. Chairman Powell highlighted that tariffs will likely push prices higher...

Stagflation Risks Back on the Table Despite Steady U.S. Data

The U.S. Federal Reserve held interest rates steady at 4.25%-4.5% on Wednesday, consistent with market expectations. However, rising inflation projections and slower growth estimates signaled an uneasy policy outlook for the second half of 2025. While recent indicators, such as job gains and consumer sentiment, were encouraging, Fed Chair Jerome Powell warned that stagflation — a toxic mix of high inflation and weak growth — may loom ahead.

The Fed’s updated personal consumption expenditures (PCE) inflation forecast for 2025 rose to above 3%, up from the previous 2.8%, while GDP growth expectations were cut to 1.4%, down from 1.7%. These shifts reflect deeper concerns about the delayed impact of tariffs and potential energy price shocks due to Middle East instability.

Powell: Tariffs Set to Drive Prices Higher

At the post-meeting press conference, Powell repeatedly emphasized the inflationary risks from tariffs, noting that most analysts forecast a meaningful rise in consumer prices over the next few months. He explained that the inflationary effects of tariffs are delayed, as current retail goods were likely imported before the levies took effect.

“Everyone that I know is forecasting a meaningful increase in inflation… because someone has to pay for the tariffs,” Powell said, adding that end consumers will bear a significant share of the burden.

Although CPI inflation in May rose just 0.1%, the Fed sees that as a temporary calm before the storm, with Powell noting that recent upbeat economic data — such as the 139,000 jobs added in May and improving consumer confidence — may not be sustainable as tariffs trickle through supply chains.

Trump's Influence and Military Tensions Complicate Policy

President Donald Trump continues to apply pressure on the Fed to cut rates, arguing they should be at least two percentage points lower. On Wednesday, he once again criticized Powell, calling him “stupid” and urging faster easing to support economic activity amid growing fiscal burdens and rising interest costs on the national debt.

At the same time, Trump has not ruled out a military strike on Iran, amid escalating tensions in the Middle East. According to JPMorgan, a regime change in Iran due to U.S. or Israeli action could have a “profound impact” on global oil markets, far more disruptive than the recent moderate spike in oil prices. While Brent crude remained stable midweek, markets remain alert to potential supply shocks that could accelerate inflation and complicate the Fed’s path.

Markets Hold Flat, But Risks Are Growing

Markets showed little reaction to the Fed’s latest announcements. The S&P 500 dropped slightly by 0.03%, the Dow Jones Industrial Average fell by 0.1%, while the Nasdaq Composite ticked up 0.13%. Oil prices were similarly flat, though lingering near recent highs. Europe’s Stoxx 600 dipped 0.36%, as the global outlook grew murkier.

The FTSE 100 edged higher by 0.11%, buoyed by U.K. inflation coming in at an expected 3.4% — further fueling the global narrative of persistent inflation.

Tariff Talks with EU Face Deadline

On the trade front, the U.S. and European Union are under pressure to finalize a deal before July 9, when a mutual suspension of tariffs expires. Without resolution, reciprocal 50% import duties could be reimposed, straining a trade relationship worth €1.68 trillion ($1.93 trillion) in 2024.

Trump expressed skepticism about current EU offers, stating: “We’re talking, but I don’t feel that they’re offering a fair deal yet.” Failure to reach an agreement could significantly affect transatlantic trade, further tighten supply chains, and stoke inflation, particularly in import-sensitive sectors.

The Fed’s June stance highlights a tense balancing act between delayed inflation pressures from tariffs, slowing economic growth, and geopolitical unpredictability. While the committee still signals two cuts by year-end, the tone is far more cautious, with Powell making it clear that uncertainty remains high and stagflation is no longer a theoretical risk — it's a looming concern. Markets may remain calm for now, but behind the scenes, policymakers are preparing for turbulent months ahead.

Source: CNBC

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Economic

BOJ's Gloomy Projections Suggest No Rate Hike This Year, Ex-top Economist Says_1

The Bank of Japan is likely to hold off raising interest rates this year unless a dramatic, positive turn of events in U.S. tariffs allows it to overhaul gloomy projections made in May, its former top economist Seisaku Kameda said.

In a quarterly outlook report released on May 1, the BOJ cut its price forecasts and said underlying inflation will stagnate for some time as uncertainty on U.S. trade policy weighs on the export-reliant economy.

The BOJ also cut its growth forecasts for both fiscal 2025 and 2026, a sign it sees the damage from U.S. tariffs to intensify later this year and last through most of next year.

"I was surprised at how dovish the BOJ's May outlook report was," said Kameda, who is well-informed in how the central bank crafts the report and the interpretation of its language.

"Having said so clearly that underlying inflation will stagnate, it would take a very positive turn of events in U.S. tariff talks for the BOJ to justify raising rates any time soon," he told Reuters in an interview on Wednesday.

Japan's exports fell in May for the first time in eight months as automakers like Toyota were hit by sweeping U.S. tariffs. Tokyo's failure so far to clinch a trade deal with Washington will likely put more pressure on a fragile economic recovery.

Given the lack of progress in trade talks and a dearth of data to gauge the impact of U.S. tariffs, the BOJ is unlikely to make substantial revisions to its growth and price forecasts at the next outlook report due on July 31, Kameda said.

"If there's a very big, positive change in U.S. tariff developments, the BOJ would take that into account in its July report," Kameda said.

"If not, the BOJ might find it hard to revise up its gloomy inflation forecast for fiscal 2026, which is key to the next rate-hike timing," he said.

Under the current projections made on May 1, the BOJ expects core consumer inflation to hit 2.2% in the year ending in March 2026 before slowing to 1.7% the following year.

For the BOJ, the key would be whether corporate capital expenditure will hold up as the bank currently projects, Kameda said.

"The BOJ will also probably want to wait for clues on whether firms will remain keen to keep hiking wages next year, Kameda said. "That means any rate hike would have to wait until January or March next year."

The BOJ ended a decade-long, massive stimulus last year and raised short-term rates to 0.5% in January on the view Japan was on the cusp of sustainably achieving its 2% inflation target.

Source: Yahoo Finance

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Economic

Market Context and Policy Shift

In response to growing market unease and volatile bond auctions, the Japanese government is poised to revise its fiscal 2025 bond issuance strategy by reducing super-long bond sales by approximately 10%. The move, outlined in a draft seen by Reuters, is designed to ease pressure on the bond market, where yields on long-dated Japanese Government Bonds (JGBs) have recently surged to record highs, triggered by poor auction results and global bond selloffs.

This is an unusual mid-year shift for Japan, which traditionally adheres to its fiscal bond plans. The decision reflects not only domestic financial considerations but also Japan’s sensitivity to global bond market dynamics and the need to prevent a widening supply-demand mismatch.

Breakdown of Changes: Super-Long Bonds Slashed, Short-Term Debt Rises

Under the revised plan, sales of the following super-long bonds will be reduced:

20-year JGBs: Reduced by 900 billion yen to 11.1 trillion yen

30-year JGBs: Cut by 900 billion yen to 8.7 trillion yen

40-year JGBs: Decreased by 500 billion yen to 2.5 trillion yen

These cuts imply that beginning next month, each of these maturities will see their auction amounts reduced by 100 billion yen. To compensate for this reduction and to maintain overall financing capacity, the Ministry of Finance will ramp up issuance of shorter-term notes and retail-oriented JGBs:

Two-year debt: Increased by 600 billion yen

Treasury discount bills (1-year and 6-month): Each raised by 600 billion yen

Principal-guaranteed household bonds: Uplifted by 500 billion yen

Overall, the annual JGB issuance for FY2025 will be revised down by 500 billion yen to 171.8 trillion yen.

Strategic Considerations and Market Impact

This adjustment is a strategic compromise. While increasing short-term issuance allows for quicker absorption by the market, it also raises refinancing risks — particularly if interest rates climb or volatility spikes. The shift away from long-term debt suggests an evolving investor profile, especially as Japanese life insurers scale back long-term purchases after meeting regulatory requirements related to solvency reforms.

In parallel, the Bank of Japan’s (BOJ) announcement to slow the pace of quantitative tightening (QT) starting next fiscal year reinforces a cautious policy stance. It suggests that despite a gradual move toward normalization, the BOJ remains sensitive to bond market fragility and does not wish to trigger further yield spikes.

There is also discussion within the government of buying back older, low-coupon super-long JGBs from the market. This would help ease the inventory glut and may offer better price support at auctions.

Global and Domestic Pressures Converge

Japan's bond market is increasingly influenced by global dynamics. The selloff in global bonds last month, triggered by concerns over U.S. debt sustainability and rising geopolitical tensions, also impacted JGBs — particularly at the super-long end, which tends to be more illiquid and sensitive to shifts in demand.

As major economies face ballooning fiscal deficits and higher interest costs, investors are scrutinizing sovereign debt sustainability more closely. Japan, with the highest public debt-to-GDP ratio among developed nations, is now recalibrating its strategy to align with market realities without compromising fiscal credibility.

Japan’s move to reduce super-long bond issuance represents a prudent, market-calming measure as the government balances fiscal flexibility with bond market stability. The rare revision shows that Tokyo is paying close attention to bond demand dynamics and is willing to adapt issuance patterns to support smoother market functioning. However, the shift toward shorter-term debt also introduces rollover risk, suggesting that Japan’s debt management strategy must remain agile amid rising domestic and global financial headwinds.

Source: Reuters

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Forex

The Indian rupee is likely to extend its recent fall at the open on Thursday, bogged down by the U.S. dollar's overall strength and risk aversion amid the ongoing Iran-Israel conflict.

The 1-month non-deliverable forward indicated a open in the 86.54 to 86.58 range, versus 86.4775 in the previous session. The Indian rupee has declined 0.5% over the last two sessions, weakening past key support zones.

A currency trader at a bank said the next support lies at 86.70–86.75, which corresponds to the mid-April low.

"The rupee was already struggling with oil prices. Now, it has to deal with the dollar regaining some safe-haven appeal—at least that’s what the price action suggests," the trader said.

The dollar indexrose 0.2% on Thursday, climbing past the 99 mark. U.S. equity futures and Asian shares slipped, while the U.S. currency advanced 0.2% to 0.8% against Asian currencies on likely safe-haven demand.

Investor attention stayed fixed on the Iran-Israel conflict and the risk of U.S. involvement, with the two countries exchanging further air strikes on Thursday.

Asked outside the White House on Wednesday whether he had decided to support Israel’s air campaign, President Donald Trump said, "I may do it. I may not do it."

Markets have so far been complacent about the Iran-Israel battle, with sentiment broadly holding up, DBS research said in a note.

However, any direct U.S. involvement could trigger a deterioration in sentiment, it said.

Meanwhile, the Federal Reserve, in line with expectations, made no changes to the policy rate, while raising its inflation forecasts and trimming growth projections.

Analysts said the updated dot plot sent mixed signals. While the Fed maintained its forecast for two cuts in 2024, it trimmed the number of projected cuts for 2025 and 2026 by one each.

DBS noted that two cuts in 2025 are dovish, while the projections for 2026 and 2027 leaned hawkish.

Source: Reuters

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Fed Holds Rates but Eyes Two Cuts in 2025

The Federal Open Market Committee (FOMC) kept its benchmark interest rate unchanged for the sixth consecutive meeting, maintaining the target range at 4.25%-4.5%. However, the closely watched dot plot indicated that two quarter-point cuts remain likely before the end of 2025, despite increasing internal divergence among Fed officials.

The Fed also trimmed its long-term easing outlook, now projecting only four rate cuts between 2025 and 2027, down from six previously expected. By 2027, policymakers anticipate the fed funds rate settling near 3.4%, though opinions varied significantly.

Notably, seven out of 19 participants now see no rate cuts this year, up from four in March—underscoring growing caution within the Fed over inflation’s persistence.

Stagflation Signals in Forecasts

The Fed’s updated economic projections reflect an uncomfortable blend of slowing growth and sticky inflation. The 2025 GDP forecast was lowered to 1.4%, down 0.3 percentage points, while inflation is now expected to hit 3%, also 0.3 points higher than previously projected. Core PCE, excluding food and energy, was revised to 3.1%, and unemployment is forecasted to rise modestly to 4.5%, above the current 4.2%.

Chair Jerome Powell acknowledged these risks during his press conference, stating the Fed remains in “wait-and-see” mode and is “well positioned to wait” before making policy changes. He reaffirmed that uncertainty has eased somewhat but emphasized that both geopolitical instability and tariff-driven inflation remain critical watchpoints.

Tariffs and Politics Cloud Policy

President Donald Trump has reintroduced substantial tariffs, and their effects are beginning to ripple through economic data. Powell warned that “the cost of the tariff has to be paid” and that rising consumer prices are likely in the coming months.

Trump, meanwhile, remains publicly critical of the Fed. On Wednesday, he repeatedly attacked Powell, saying rates should be 2 percentage points lower, calling the Fed Chair “stupid” for not easing faster. The 90-day trade negotiation window may ease tensions slightly, but the administration’s aggressive fiscal and trade posture is clearly complicating the Fed’s inflation outlook.

Market Reaction and Economic Data Signals

Markets were largely unmoved immediately after the Fed’s announcement, with equities flat and yields steady. However, the underlying economic data suggests growing downside risks. Retail sales fell nearly 1% in May, while housing starts hit a five-year low. Layoffs are increasing, and long-term unemployment is ticking up, contributing to a sense of creeping stagnation.

Chris Zaccarelli of Northlight Asset Management summarized the market’s perception: the Fed is “sitting on their hands,” waiting for a decisive shift in inflation or employment. The bias remains toward easing, but only if data supports it.

Debt Pressure and Political Influence

One of Trump’s key motives in pushing for rate cuts is fiscal. With $36 trillion in national debt and $1.2 trillion in projected interest payments this year, debt servicing has become the government’s third-largest expenditure, trailing only Social Security and Medicare. Sustained high interest rates strain the budget and fuel political urgency to lower borrowing costs.

The Fed's June decision reflects a precarious balance: inflation remains elevated, but growth is slowing, and political pressure is intensifying. The central bank still expects to cut rates twice in 2025, but any action will depend on whether tariffs accelerate inflation or whether labor market weakness forces its hand. For now, the Fed is holding firm—poised to pivot only when the data demands it.

Source: CNBC

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Stocks

Heightened Geopolitical Risk Pressures Asian Stocks

Markets across Asia declined on Thursday as investors reacted to intensifying geopolitical uncertainty. President Donald Trump’s ambiguous remarks—“I may do it. I may not do it”—regarding a possible U.S. strike on Iran kept markets on edge. The Wall Street Journal added to the tension by reporting that while Trump has approved military plans, he is waiting to see whether Tehran halts its nuclear activities.

Amid this uncertainty, Japan’s Nikkei 225 dropped 0.8%, weighed further by a strengthening yen that undermines export earnings. Taiwan’s TAIEX slipped 0.9%, and Hong Kong’s Hang Seng Index lost 0.8%, reflecting broader investor retreat from risk assets. U.S. equity futures also pointed lower, with S&P 500 futures down 0.4%, though U.S. markets were closed for the Juneteenth holiday.

Gold and Yen Attract Safe-Haven Demand

As risk sentiment soured, safe-haven assets gained favor. Gold rose 0.3% to $3,378 per ounce, moving toward recent highs as investors sought shelter from potential military escalation and economic fallout. The Japanese yen firmed to 144.92 per dollar, up 0.2%, supported by its traditional safe-haven status.

The U.S. dollar also strengthened, gaining 0.1% against the euro to $1.1472 and 0.2% against sterling to $1.3398. Meanwhile, the Swiss franc edged slightly lower to 0.8193 per dollar, ahead of a key policy decision from the Swiss National Bank (SNB).

Oil Prices Hold Despite Conflict Fears

Despite growing concern over Middle East stability and global energy supplies, Brent crude edged down to $76.32 per barrel, not far from its recent high of $78.50, a 4.5-month peak. Market participants appear to be cautiously watching for actual disruptions before driving prices higher.

Analyst Kyle Rodda of Capital.com noted, “The fear is that if the U.S. intervenes, it would mark a material escalation, potentially triggering retaliation by Iran, raising the risk of broader regional conflict and energy supply shocks.”

Central Banks in Focus Amid Market Uncertainty

Investors also turned their attention to major central banks. The Bank of England is expected to hold rates steady, while the Swiss National Bank may cut rates by 25 basis points, continuing its effort to ease monetary conditions amid softening inflation.

In the U.S., the Federal Reserve maintained rates and its outlook for two 25-basis-point cuts in 2025, but Chair Jerome Powell cautioned that tariffs imposed by the Trump administration could cause “meaningful” inflation in the coming months. His comments added to uncertainty, as markets balance the risk of sticky inflation against signs of slowing growth.

The confluence of rising geopolitical tensions, cautious central bank policy, and uncertain inflation outlooks has made investors increasingly risk-averse. With the specter of U.S. military action in the Middle East and a global economy still adjusting to monetary policy shifts, markets may remain volatile in the near term. Investors are now watching closely for further developments from both Washington and Tehran, as well as upcoming inflation data and central bank statements.

Source: Reuters

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Economic

Employment Declines Against Expectations

Australia’s labor market posted a surprise contraction in May, losing 2,500 jobs, contrary to economists’ forecast of a 21,200 gain. The decline was entirely due to a sharp 41,100 drop in part-time jobs, partially offset by a 38,700 rise in full-time positions, according to data released by the Australian Bureau of Statistics.

The unemployment rate held steady at 4.1%, but this was largely due to a marginal dip in the participation rate to 67%, suggesting that fewer people were actively looking for work. This trend points to hidden slack in the labor market, and although joblessness remains historically low, the upward drift from its post-pandemic low of 3.4% reflects a steady deterioration in labor market momentum.

Implications for Monetary Policy

The data arrives at a sensitive time for the Reserve Bank of Australia (RBA). Since adopting a more dovish tone in its May meeting—where it lowered rates for the second time this year—the central bank has hinted that future decisions would depend on domestic demand and external pressures. The current job figures, while not disastrous, strengthen the case for another rate cut at the July 8 meeting, which is already priced in at 80% probability by money markets.

APAC economist Callam Pickering of Indeed observed that forward-looking indicators of labor demand remain robust, but “the data will continue to take a backseat to economic and geopolitical uncertainty.” He expects the RBA to implement at least two more cuts by September, reducing the cash rate from 3.85% to potentially 3.35% in staged moves.

Geopolitical Risks and Economic Headwinds

Beyond the domestic slowdown, Australia faces intensified global risks. Surging oil prices driven by escalating Israel-Iran tensions, as well as higher U.S. tariffs, sluggish Chinese demand, and the persistent Ukraine-Russia war, present further downside threats. Treasurer Jim Chalmers acknowledged these risks earlier in the week, describing the global economy as “a pretty dangerous place” and warning that Australia “won’t be immune.”

These external shocks add further justification for accommodative monetary policy, as rising costs and declining export demand could strain households and businesses already coping with slower income growth and persistent cost-of-living pressures.

Labor Market Trends Behind the Headline

Annual employment growth still outpaces population growth, with jobs up 2.3% year-on-year versus 2.1% population growth among working-age Australians. However, the underlying shift toward full-time work at the expense of part-time roles could suggest some rebalancing in job quality.

Underemployment fell slightly to 5.9%, and underutilization (combining underemployment and unemployment) dropped to 9.9% from 10.1%, indicating some efficiency in labor use. Yet, economists warn these positive signals may not hold if broader public sector hiring trends reverse.

Indeed, Commonwealth Bank’s Harry Ottley noted that 80% of jobs growth since 2023 came from the non-market sector—mainly healthcare, education, and public administration, all heavily funded by government outlays. Alarmingly, this segment contracted last quarter for the first time since 2021, with its annual growth rate plunging from 8.3% to 4.8% in just six months. If this slowdown persists, total employment could begin to decline more sharply in the second half of 2025.

While the May job report shows only modest overall losses, the weakening part-time sector, falling participation, and potential peaking of public sector job creation suggest that Australia’s labor market is softening. Combined with heightened external risks, the RBA is likely to proceed cautiously, leaning further into monetary easing to shield the economy from a broader downturn. Markets now expect July to bring another rate cut, with more likely before year-end if downside risks materialize.