Stagflation Could Hit As Fed Cuts Rates in an Accelerating Economy

The worst-case inflation scenario is on one firm’s radar.

While most forecasters are growing confident about the economy’s resilience, macro research firm TS Lombard says it’s eyeing the risk that the US could see a burst of inflation similar to the run-up in consumer prices that led up to the stagflation crisis of the 1970s.

Stagflation, a scenario where the economy slows while inflation remains stubbornly high, is thought to be even harder for policymakers to resolve than a typical recession. That’s because hotter inflation leaves the Fed’s hands tied when it comes to cutting interest rates to boost the economy, as it would in a typical downturn.

The situation is considered to be a fringe risk among most economic forecasters, particularly since recent inflation data has been tame and growth has been strong.

The Fed, meanwhile, just restarted its rate-cutting cycle at its September policy meeting.

But that policy move could be the start of a mistake, Dario Perkins, TS Lombard’s head of global macro, said in a client note on Thursday.

“Fed officials are worried that the labour market is about to stall, which is why they’ve resumed their cutting cycle even though tariffs will likely keep inflation above their target. We think these worries are overstated,” Perkins said, referring to concerns about the job market.

“The Fed could be cutting into a reacceleration, with echoes of the late 1960s,” he added, referring to the period when the Fed began cutting interest rates before inflation began to spike.

Perkins said that he believed inflation had been cooling in 2025 due to “significant negative supply shocks” in the economy, referring to the impact of tariffs on production and trade.

Demand has also shown signs of weakness lately, given uncertainty around tariffs and concerns about the US job market.

But the economy could see demand re-accelerate into 2026, Perkins said, a dynamic that could stoke higher prices for consumers. He sees four reasons that the demand side of the economy could heat up:

1. Pent-up demand. Uncertainty around tariffs and the job market could start to fade into 2026, leading consumers to ramp up their spending.

   “If uncertainty has been a major constraint on US demand in 2025, this can be expected to reverse in 2026, once tariff policy, etc. settles down,” Perkins said, speculating that drops in output and employment this year could be added to 2026’s totals.

2. Fed easing. The impact of looser monetary policy should show up “quickly” in areas of the economy most sensitive to interest rate changes, such as housing and consumer goods, Perkins said.

   The housing market is already showing signs that demand is starting to pick up. Sales of new homes jumped 20% for the month of August as rates started to ease. Mortgage and refinancing activity also spiked in September, according to MBA data.

3. Other central banks easing. “While the Fed has only just restarted its easing cycle, many other central banks have been cutting rates repeatedly for the past 12 months. This coordinated stimulus should boost global growth in 2026,” Perkins wrote.
4. Fiscal stimulus. Some of Trump’s policies, like stimulus in the “One Big Beautiful Bill,” are expected to juice demand in the economy. Other nations around the world, like Germany and China, have also recently announced fiscal stimulus programs, Perkins said.

If demand does pick up, and the Fed continues to push forward with its rate-cutting cycle, that could result in sticky and possibly re-accelerating inflation, Perkins speculated, adding that he saw parallels with the Fed’s easing cycle during 1967.

Inflation began to rev up in the late 1960s and accelerated for much of the following decade. The pace of inflation touched nearly 15% by 1980, at which point the US was considered to be well into a stagflationary crisis.

“We are not saying things will turn out that badly this time, but the combination of rate cuts, supply shocks and political interference in monetary policy could be leading us down a dangerous path,” Perkins said.

Most forecasters don’t expect the economy to slip into a recession or see full-blown stagflation. But investors are starting to question if the Fed has as much room to cut interest rates as previously thought, given the continued resilience of the US economy.

The priced-in probability that the Fed will keep its target rate on hold jumped to 14% from 8% on Thursday as markets took in strong GDP growth and lower-than-expected jobless claims. The probability that the Fed will follow through with two more rate cuts by the end of the year also decreased from 73% to 63%, according to the CME FedWatch tool.