Creeping stagflation muddies outlook

Potential for U.S. economic ‘stall speed’ as activity wanes and prices rise

Something had to be the catalyst. After a steady, upward march of U.S. equities valuations, especially those of large growth companies, something had to precipitate a reversal. We know now, after three days of sharp global stock market losses and dizzying volatility, that the April 2 U.S. tariff announcements were that catalyst.

The degree of tariff imposition surprised markets. That much is clear. What is not clear is how long tariffs may remain at their announced levels. We are dancing with recession.

Lower U.S. growth, higher inflation

By our calculations, and with the potential for further tariff announcements, the average effective U.S. tariff rate could rise above 25%, well above the baseline we had anticipated at the start of the year. The global marketplace was far less integrated the last time tariffs were that high, more than a century ago. Although we don’t expect the rate to remain at that level given the prospect of negotiations, one that settles just below 20% (our baseline) still augurs significant economic ramifications. The effective U.S. rate before the latest tariffs was below 5%.

Under our revised baseline scenario, 2025 U.S. GDP growth would fall below 1%, nearly a percentage point below our previous forecast. That would put the economy at a potential “stall speed” that raises the specter of recession. We also foresee core inflation ending 2025 at nearly 4% year over year, more than a percentage point above our previous forecast. Unemployment that we foresee rising to just above 5% by year-end would be the highest in a decade outside the Covid-19 era.

The combination of stagnating activity and rising prices introduces the prospect of stagflation that would be a strong headwind for both stocks and bonds. Given their dual mandate, the Federal Reserve may be challenged to lower rates meaningfully amidst a push and pull of lower growth and higher inflation. In the end, the Federal Reserve is likely to lower rates in the event of the labor market weakening further.

Outside the U.S., we anticipate weakening economic growth, although softening demand will likely temper any inflationary impulses.

Long-term investing success happens now

We knew such a day was coming. Sharp market downturns are a surprise only in their timing, not in their mere occurrence. This day was coming because it always comes. How we’ve prepared and what happens next is of the utmost importance. Don’t chase the markets; in times like these, they’re wild and unpredictable. Now is the time to call on that discipline you signed up for if you’ve adopted our Principles for Investing Success.

Eventually, and not necessarily in this order, volatility subsides, markets bottom, and dances end.

Joseph H. Davis, PhD, is a Vanguard principal, global chief economist, and global head of The Vanguard Group, Inc.’s Investment Strategy Group, whose research and client-facing team develops asset allocation strategies and conducts research on the capital markets, the global economy, portfolio construction and related investment topics. As Vanguard’s global chief economist, Mr. Davis is also a key member of the senior portfolio management team for Vanguard Fixed Income Group.

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