Stagflation Ahead? Fed Faces Tightrope Walk as Inflation Persists, Growth Slips

Economic data released yesterday painted a concerning picture for the US economy. While markets have largely avoided panic, the numbers suggest the much-desired soft landing may be increasingly unlikely.

GDP growth came in at a sluggish 1.6% QoQ, falling short of expectations. Core PCE inflation, a key metric for the Fed, surprised on the upside at 3.7%, marking the highest level since last November. This combination of slowing growth and persistent inflation raises the risk of stagflation – a scenario the Federal Reserve is desperately trying to avoid.

Further data releases in the coming weeks will be crucial. If the current trend holds, the Fed, aiming for a soft landing, may now face a tougher challenge. Policymakers will have to navigate a delicate balancing act – taming inflation without triggering a recession.

Stocks, Currency Pairs Awaiting Fed's Next Move

Both currency and equity markets struggled to find direction yesterday. The EUR/USD initially dipped but clawed its way back to positive territory by day's end. Similar behavior was seen in the S&P 500 and NASDAQ, which recovered losses, suggesting the worst-case scenario isn't yet upon us.

Markets are likely to remain cautious as they await key data from the US labor market and, most importantly, the Federal Reserve meeting this Wednesday. With no interest rate changes expected, all eyes will be on the accompanying statement and Jerome Powell's press conference for clues on the Fed's future direction.

Pivot or Pause?

According to Bloomberg, Treasury Secretary Yellen is optimistic, believing the US economy can handle inflation without significant job losses. This raises the question of what path the Fed might make.

The first, and more market-friendly scenario, would involve the Fed cutting rates once inflation reaches its target. This would be positive for financial markets. However, the Fed also needs to watch economic growth and prevent a recession. If they change their stance to dovish to combat a recession, inflation could surge once again.

US Dollar Retreats

Since mid-April, the US dollar has been in a correction. The first target for bears is the 105-point zone, which also coincides with a major correction point in the prior uptrend.

Just below this lies a key support level defined by the uptrend line. A break below this support could signal a breakdown of the local uptrend. If that happens, sellers might target the next demand zone around 104 points.

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Disclaimer: The author does not own any of these shares. This content, which is prepared for purely educational purposes, cannot be considered as investment advice.