Assessing the Risk of a U.S. Economic Stall Speed and the Implications for Equity and Fixed Income Markets

The U.S. economy stands at a crossroads. With growth projected to stagnate near 1.4% in 2025 and 1.5% in 2026 [1], the risk of a “stall speed” economy—a condition of tepid growth and persistent inflation—has become a defining challenge for policymakers. The Federal Reserve’s gradual rate-cutting trajectory, combined with a fiscal policy landscape marked by both stimulative and contractionary forces, will shape the path of equity and fixed income markets in the coming year. This analysis examines how these dynamics could catalyze a market rebound—or deepen uncertainty.

The Fed’s Delicate Balancing Act

The Federal Reserve’s June 2025 projections signal a cautious easing of monetary policy, with the federal funds rate expected to fall from 3.9% at year-end 2025 to 3.6% by 2026 [2]. However, market expectations and private-sector forecasts suggest a more aggressive timeline. J.P. Morgan Research anticipates a 25-basis-point cut in September 2025, followed by three more reductions before the year’s end [3], while Morningstar projects 50 basis points of cuts in 2025 alone [4]. These moves reflect the Fed’s response to a softening labor market—evidenced by weak July 2025 employment data—and moderating inflation, which is expected to fall from 3.0% in 2025 to 2.4% in 2026 [2].

Yet the Fed’s path is constrained by lingering inflationary pressures, particularly from tariffs. The St. Louis Fed estimates that tariffs have pushed core inflation above the 2% target, with a 20% pass-through to consumer prices [5]. This complicates the central bank’s dual mandate, as rate cuts aimed at boosting growth risk exacerbating inflation if supply-side distortions persist. The result is a policy environment of “conditional easing,” where cuts are contingent on data confirming a sustainable decline in inflation and stable growth.

Fiscal Policy: A Mixed Bag

Fiscal policy in 2025–2026 has been a double-edged sword. The Hutchins Center Fiscal Impact Measure (FIM) reports that federal spending cuts and state-level fiscal adjustments reduced GDP growth by 0.4 percentage points in Q2 2025 [1]. Meanwhile, the One Big Beautiful Bill Act (OBBB) is projected to add 0.22 percentage points to GDP in 2025 and 0.31 points in 2026 [1], though its stimulative effects are offset by deficit concerns.

Tariffs, meanwhile, have emerged as a drag on long-term growth. Yale Budget Lab analysis reveals that tariffs enacted in 2025 alone reduced real GDP by 0.9 percentage points [6], with cumulative effects shrinking the economy by 0.4–0.6% in the long run [6]. These policies, while politically popular, have introduced uncertainty that dampens business investment and hiring. Deloitte’s baseline forecast assumes average tariff rates of 15% through 2026, contributing to a “muted” GDP growth trajectory [1].

Historical Precedents and Market Implications

History offers mixed lessons for equity and bond markets during rate-cutting cycles. In 2020, the Fed’s emergency rate cuts to near-zero levels coincided with a 20% rally in the S&P 500 within months [7]. However, during the 2008–2012 period, aggressive rate cuts and quantitative easing failed to immediately revive housing markets or equity indices, which required years to recover [8]. This suggests that while lower rates create favorable conditions, broader economic confidence and sector-specific dynamics are critical.

For equities, the 2025–2026 outlook hinges on sectoral resilience. Industries insulated from tariff effects—such as private real estate and technology—may outperform, while sectors like manufacturing and retail face headwinds [9]. The S&P 500’s performance could mirror the 1995 rate-cut cycle, where the index surged 21.4% in the 12 months following easing [10]. However, a stall-speed economy could limit gains, particularly if corporate earnings remain pressured by high debt costs and weak consumer demand.

Fixed income markets, meanwhile, face a tug-of-war between falling rates and inflation risks. The 10-year Treasury yield is expected to decline as rate cuts reduce borrowing costs, but persistent inflation and a bloated national debt ($36.2 trillion as of 2024 [11]) could cap bond rallies. Schwab’s analysis notes that a “positively sloped yield curve” may emerge, reflecting higher long-term inflation expectations despite short-term easing [12]. Investors may favor high-credit-quality bonds, such as Treasuries and investment-grade corporates, while avoiding lower-grade debt in a slowing economy [12].

Political Pressures and Policy Uncertainty

The Federal Reserve’s independence has faced growing political scrutiny, with public criticism influencing its credibility. A report by AInvest highlights how divergent inflation expectations—3.2% for consumers versus 3.5% for businesses—have driven bond yields higher, with the 30-year Treasury reaching 4.8% by late 2025 [13]. This uncertainty has spurred demand for inflation-protected assets like TIPS and gold, as well as defensive equities in healthcare and utilities [13].

The September 2025 Jackson Hole symposium will be pivotal. With markets pricing in an 83% probability of a 25-basis-point rate cut [13], the Fed’s communication strategy will shape investor sentiment. A shift toward a more accommodative policy framework—such as abandoning the flexible average inflation target—could further tilt capital flows toward equities and away from bonds.

Conclusion: A Rebound, But at What Cost?

The interplay of Fed rate cuts and fiscal policy shifts in 2025–2026 presents both opportunities and risks. A gradual easing of monetary policy, combined with targeted fiscal stimulus, could catalyze a market rebound, particularly in equities and high-quality fixed income. However, the drag from tariffs, political pressures on the Fed, and fiscal sustainability concerns pose significant headwinds. Investors must navigate this duality by prioritizing sectors and assets insulated from macroeconomic volatility while remaining vigilant to policy-driven uncertainties.

As the Fed inches toward its projected 3.25–3.5% policy rate by early 2026 [3], the coming months will test whether the U.S. economy can escape stall speed—or if structural challenges will demand even more aggressive intervention.

Source:
[1] Deloitte, United States Economic Forecast Q2 2025 [https://www.deloitte.com/us/en/insights/topics/economy/us-economic-forecast/united-states-outlook-analysis.html]
[2] Federal Reserve, June 18, 2025: FOMC Projections [https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20250618.htm]
[3] J.P. Morgan Research, What's The Fed's Next Move? [https://www.jpmorgan.com/insights/global-research/economy/fed-rate-cuts]
[4] Morningstar, How Much Will the Fed Cut Interest Rates? [https://www.morningstar.com/markets/when-will-fed-start-cutting-interest-rates]
[5] St. Louis Fed, Economic Conditions, Risks and Monetary Policy [https://www.stlouisfed.org/from-the-president/remarks/2025/economic-conditions-risks-monetary-policy-remarks-peterson-institute]
[6] Yale Budget Lab, Where We Stand: The Fiscal, Economic and Distributional Effects of All U.S. Tariffs Enacted in 2025 Through April [https://budgetlab.yale.edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffs-enacted-2025-through-april]
[7] JPMorgan, Rate Cut Breakdown: What You Need to Know Now [https://privatebank.jpmorgan.com/nam/en/insights/markets-and-investing/tmt/rate-cut-breakdown-what-you-need-to-know-now]
[8] Federal Reserve History, Federal Funds Rate History [https://www.bankrate.com/banking/federal-reserve/history-of-federal-funds-rate/]
[9] Deloitte, United States Economic Forecast Q2 2025 [https://www.deloitte.com/us/en/insights/topics/economy/us-economic-forecast/united-states-outlook-analysis.html]
[10] Visual Capitalist, What History Reveals About Interest Rate Cuts [https://www.visualcapitalist.com/sp/what-history-reveals-about-interest-rate-cuts/]
[11] U.S. Bank, The Impact of U.S. National Debt on Investments [https://www.usbank.com/investing/financial-perspectives/market-news/national-debt.html]
[12] Schwab, Bond Markets Reach a Turning Point [https://www.schwab.com/learn/story/bond-markets-reach-turning-point]
[13] AInvest, The Politicalization of the Federal Reserve and Its Implications for Financial Markets [https://www.ainvest.com/news/politicalization-federal-reserve-implications-financial-markets-2509/]