As expected, the US Federal Reserve left the policy rate unchanged at 4.25 per cent to 4.50 per cent on June 18, reiterating the risks arising from the trade war triggered by President Donald Trump’s tariff policies.
The Fed remains in “wait-and-watch’ mode as it is early to authentically assess the real effective impact of Trump’s tariffs on the world’s largest economy.
Amid tariff-led uncertainty, the Fed believes inflation will rise and growth will falter in the US. Fed Chair Jerome Powell said inflation may accelerate over the summer as the impact of President Donald Trump’s tariffs reaches US consumers.
The Fed forecast GDP growth of 1.4 per cent in 2025, down 0.3 per cent from the March meeting. By the end of the year, it sees unemployment rising to 4.5 per cent and inflation at 3 per cent, well above the current level.
The Fed’s outlook for the US economy carries hues of stagflation.
How big is the US stagflation risk?
At the current juncture, the US economy is in healthy shape. Inflation eased surprisingly in May, even though experts expected a spike after Trump’s “Liberation Day” tariff announcements on April 2.
The US consumer price index (CPI) increased 0.1 per cent month-on-month in May, while year-on-year it rose 2.8 per cent.
K. Joseph Thomas, the head of research, Wealth Management at Emkay Global Financial Services, pointed out that inflation fell in the US, as in the run-up to tariff announcements, consumer spending spiked in the US, which subdued the price impact to some extent.
However, Thomas highlighted that the Fed is still wary of the likely nature of the incoming inflation data, and they believe that the fog of uncertainty is still clouding the vision. Therefore, any future rate cuts would be data-dependent.
“A close look at the US growth and inflation numbers underlines the potential for economic growth to slow down further, with growth numbers coming down sequentially, and the latest number indicating a contraction. The numbers point to the potential for stagflation, and no full-fledged stagflation exists at present,” said Thomas.
Devarsh Vakil, Head of Prime Research at HDFC Securities, observed that the US economy is experiencing a period of measured deceleration, with real GDP growth projections revised downward to 1.4 per cent for 2025 and 1.6 per cent for 2026, representing a notable reduction from earlier March forecasts.
This moderation reflects both cyclical adjustments and policy-driven uncertainties that are reshaping economic dynamics.
While the US economy currently navigates a complex environment of slowing growth and persistent inflation pressures, Vakil underscored that the combination of labour market strength, measured wage growth, and responsive monetary policy significantly reduces the probability of a stagflationary outcome in the near term.
“Key risk factors to monitor include the evolution of trade policy impacts, trends in consumer confidence, and the Federal Reserve’s ability to strike a balance between its dual mandates. Success in managing these elements will largely determine whether the current economic deceleration represents a healthy adjustment or a more concerning structural shift,” said Vakil.
How a slowdown in the US economy may affect the Indian market?
A slowdown in the US economy may not have a direct impact on India, given that the Indian economy is largely driven by domestic demand. However, the US Federal Reserve’s interest rate decisions will influence the movement of the dollar and could affect the investment stance of foreign portfolio investors (FPIs). A prolonged pause by the Fed may also delay rate cuts by other central banks, potentially tightening global liquidity conditions.
Thomas believes US-centric developments may not seriously affect domestic economic growth, which is driven mostly by domestic demand.
“External factors may have only a fleeting influence on the macro variables or the markets. The fundamentals being strong for the economy beyond the immediate future, the domestic market is expected to further progress in its secular uptrend,” said Thomas.
The Fed’s reluctance to reduce rates may also lead to caution among other central banks, including the RBI.
“The expediency to lower the rates is lowered for the other central banks. This applies to the RBI too, and the RBI has already moved away from an accommodative stance to a neutral stance. The decline in the dollar against currency majors may face some immediate challenges. The reversal of the trend witnessed so far may gradually get reflected in the dollar index,” said Thomas.
Vakil pointed out that the weakening US dollar, primarily due to escalating concerns over the mounting debt burden and fiscal sustainability of the US, is creating additional incentives for USD-based investors to explore offshore opportunities.
“A depreciating dollar not only erodes the relative attractiveness of US assets but also enhances the appeal of foreign investments when converted back to dollars,” said Vakil.
Vakil believes emerging markets, particularly India, are positioned as primary beneficiaries of this capital reallocation, offering compelling growth prospects, improving corporate governance, and attractive valuations relative to developed markets.
“India’s robust economic fundamentals, expanding market capitalisation and increasing inclusion in global indices make it an attractive destination for investors seeking alternatives to US market exposure,” said Vakil.
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Disclaimer: This story is for educational purposes only. The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions, as market conditions can change rapidly, and circumstances may vary.
