Federal Reserve Chairman Jerome Powell pushed back last week when asked whether stagflation was a threat to the US economy. His successor could face a tough challenge, as Wall Street forecasters fear a recession due to the Iran war and the possibility of higher prices.
In recent days, economists have raised their risk assessments of a U.S. contraction amid geopolitical risks and growing uncertainty over the labor market, which has seen tension over the past year.
The Moody’s Analytics model has raised its recession forecast for the next 12 months to 48.6%. Goldman Sachs raised its estimate to 30%. Wilmington Trust has a probability of 45%, while EY Parthenon has a probability of 40%, with the warning that “these probabilities could increase sharply in the event of a more prolonged or severe Middle East conflict.”
In normal times, the risk of a recession in any 12-month period is about 20%. So while current predictions are hardly certainties, they do indicate an increased risk.
This situation poses a difficult challenge for policymakers, who are being asked to balance labor market risks against sticky inflation.
“I worry that the risk of a recession is uncomfortably high and rising,” said Mark Zandi, chief economist at Moody’s Analytics. “Recession is a real threat here.”
war inspires fear
Talk of economic contraction has intensified The war with Iran has dragged on for a long time.
An oil shock has preceded almost every recession seen in the US since the Great Depression, except the Covid pandemic. Prices at the pump have increased $1.02 per gallon in the past month, a 35% increase, according to aaa.
While economists are still debating the impact of higher energy, the trend continues.
“The negative consequences of higher oil prices happen early and quickly,” Zandi said. “If oil prices remain where they are through Memorial Day, certainly through the end of the second quarter, it will push us into a recession.”
Like his fellow forecasters, Zandi said his “baseline” expectation is that the warring sides get a diplomatic off-ramp, oil flows through the Strait of Hormuz again and the economy avoids the worst.
To be sure, most economists are pessimistic and subject to the old adage of predicting nine out of the last five recessions. The markets are also wrong about where the economy is headed. One part of the yield curve – or the spread between different Treasury maturities – is most closely watched by the Fed, which has repeatedly sent false recession signals over the past three and a half years.
But the threat of a prolonged war, pressure on a consumer that drives more than two-thirds of all growth, and a labor market that created almost no jobs in 2025 collectively pose the threat that the expansion could falter.
“That path is getting narrower and narrower and harder to see the other way,” Zandi said.
Consumers are also pessimistic. Consumer site NerdWallet said this march survey It found that 65% of respondents expect a recession in the next 12 months, up 6 percentage points from last month.
trouble in job
Beyond energy prices, economists say the labor market is a major pressure point.
US economy to create only 116,000 jobs in all of 2025 There was a loss of 92,000 in February. While the unemployment rate remains steady at 4.4%, this is largely due to a lack of firings rather than an uptick in hiring.
Furthermore, the labor market is plagued by a limited number of appointments. Excluding strong gains in health care-related sectors – by more than 700,000 overall – payrolls outside those sectors have declined by more than half a million over the past year.
“I think the inflation risk is much lower than (Fed officials) have stated, and the risk of a labor market downturn is much higher than they have stated,” said Luke Tilley, chief economist at Wilmington Trust.
“In the future we’re going to have more people who need more health care,” said Dan North, senior U.S. economist at Allianz. “There’s going to be a demand for those jobs. But there’s no way to run a railroad if you’re doing it on an engine.”
Of course, employment is a key driver of consumer spending, which remains strong despite rising prices and concerns about growth.
Those twin concerns have prompted discussion about stagflation, the combination of rising inflation and slow growth that plagued the US in the 1970s and early ’80s. Fed chief Powell rejected this characterization at a press conference after last week’s policy meeting, in which the central bank kept its benchmark interest rate between 3.5%-3.75%.
“I always have to point out that that was the tenure of the 1970s when unemployment was in double figures and inflation was really high,” he said. “That’s not the case right now.”
Powell said, “It’s a very difficult situation, but it’s nothing like they faced in the 1970s, and.. I reserve the term stagflation for that period. Maybe it’s just me.”
cracks in the foundation
Then again, the current situation may be more like stagflation – a situation that is not as obvious as the previous episode but still poses risks. Consumer sentiment has been generally poor, held back primarily by those at the bottom of the income spectrum, who have been particularly hard hit by higher prices.
Wilmington Trust’s Tilley warned that spending has been heavily supported by rising property prices, a dynamic that cannot continue.
“We estimate that the money flow from the stock market has driven 20% to 25% of spending growth over the last two years,” he said. “If you don’t get the wealth effect boost, you’ll lose a lot of growth.”
Since the beginning of the war, Dr.
Gross domestic product is on track to grow at a 2% pace in the first quarter, according to the Atlanta Fed gdpnow Tracker of rolling data. However, there was only a 0.7% increase in the fourth quarter, due in part to the government shutdown. Economists had expected the decline in growth in the fourth quarter to offset growth in the first quarter, but the impact appears to be modest.
Still, if global leaders can find an end to the war soon, there is hope that the economy will again escape the most gloomy predictions. The stimulus from the One Big Beautiful bill in 2025 is projected to slow growth and increase tax returns, which could help consumers cope with higher prices. Continued growth in production is also a factor in favor of the economy.
“There is support below,” said North, the Allianz economist. “It makes me really hesitate to use the ‘R’ word. But certainly, I think we’re seeing a recession this year.”
