Strategists Warn of Stagflation as S&P 500 Hits New Highs

Wall Street strategists have issued warnings that the U.S. economy is sliding into stagflation, a period characterized by persistent inflation and sluggish economic growth. Despite these warnings, investors have largely ignored the signals, with the S&P 500 index hitting new highs and the U.S. bond index poised for its best performance since 2020. The strategists caution that the impact of tariff policies is beginning to manifest, potentially limiting the Federal Reserve's ability to significantly lower interest rates.

On August 7, analysts reported that data indicates an approaching period where inflation remains sticky and economic growth weakens. However, investors have largely overlooked these warning signs, as the S&P 500 index has reached multiple new highs this year, and the U.S. bond index is on track for its best performance since 2020. Currently, traders believe that inflation is under control and are betting on two interest rate cuts by the Federal Reserve this year, with the first possible cut as early as next month. Last Friday's employment data showed a cooling in hiring activity, further fueling these bets.

However, strategists warn that the "reciprocal tariffs" implemented by the Trump administration on August 4 could upend market expectations. Higher prices resulting from these tariffs could be passed on to consumers and businesses, potentially driving up inflation levels. Multiple investment banks have issued stagflation warnings. The chief economist of a prominent investment firm noted that while the market expects rate cuts, the risk of rising inflation is significant. This sentiment is echoed by strategists from several major banks, who argue that the evolving tariff landscape will prove stagflationary, reducing growth while increasing inflation.

The latest inflation data, to be released on August 12, is expected to show a year-over-year increase of 2.8%. Despite the Federal Reserve's chairman acknowledging that the economy is slowing and that adjusting the federal funds rate may become appropriate in the short term, he also noted that tariffs remain a significant variable. If inflation rises due to tariffs, the Federal Reserve may even consider raising rates again, as the impact of tariffs on the U.S. economy is still uncertain.