Stagflation fears return

• New US tariffs, firmer inflation and weak payrolls all point to our base case of US stagflation
• The Fed will wait for more data, but risks are tilting to earlier rate cuts now, weakening the USD

First, the US set harsh new ‘reciprocal’ tariffs on dozens of countries that haven’t yet agreed new trade deals. China’s remains 30% but the highest tariffs for Mexico and Canada rise to 25% and 35% while India’s, Taiwan’s and Switzerland’s rates are 25%, 20% and 39% respectively. Yale Budget Lab estimates the US average tariff rate now stands at 18.3%, the highest since 1934.

Second, US inflation is firming. June’s change in core personal consumption expenditure (PCE) prices ticked up to 2.8%, well above the Federal Reserve’s 2% goal. July’s average hourly earnings, a measure of wage growth, also rose to 3.9%, and the Q2’25 employment cost index was higher than expected, rising 0.9%QoQ.

Third, US activity is weakening. Q2’25 data showed GDP expanded by an annualised rate of just 1% in H1’25. July’s ISM manufacturing survey fell from 49.0 to 48.0, levels indicating contraction, and July’s jobs report shocked investors. Last month payrolls only rose 73,000 while huge revisions cut May’s and June’s gains to just 19,000 and 14,000. In contrast, payrolls rose 122,000 on average from January to April.

Source: Bank of Singapore, Bloomberg

The Fed faces even more pressure to cut interest rates. President Trump fired the Bureau of Labour Statistics head after the data while Fed Governor Kugler said she would retire giving Trump an opening to nominate Chair Powell’s successor.

But inflation is rising while weak payrolls growth may be due to both lower demand for and supply of labour. Unemployment at 4.2% has gone sideways for a year, low weekly jobless claims signal firms are not firing, and immigration curbs are reducing labour force participation.

We think the Fed will thus wait for more data. But the risks of earlier rate cuts are rising, weakening the USD while keeping Treasury yields volatile.

This article was first published by Bank of Singapore on 4 August 2025. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of OCBC Private Bank or its affiliates.

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