The U.S. Economy is in Stagflation
Last Wednesday, the Federal Reserve announced that the federal funds rate will remain unchanged at 3.5% to 3.75%. The fed funds rate is the interest rate that banks charge each other for overnight loans. The Fed has held this rate steady at all three meetings so far this year after making three successive cuts to the bank lending rate close out last year.
The official statement from Chairman Powell left the door open for rate cuts later this year, but there were two hints that I think show that the Fed is unlikely to cut rates in 2026.
The first hint was three dissenting opinions from Federal Open Market Committee (FOMC) members, which were opposed to the inclusion of language showing a bias toward easing interest rates. There were four dissents in all—the highest total for a FOMC meeting since 1992.
Powell said the quiet part out loud.
The second hint came at the press conference, after Powell’s prepared remarks. In his answer to a question from a reporter, Powell admitted that tariffs are having a more significant impact on inflation than the Fed and others expected. And then he said the quiet part out loud: “I think we’d want to see the backside of that and progress on tariffs before we even thought about reducing rates.”
The Fed’s official statement was crafted to give markets hope of a rate cut later this year, but I think the dissents and Powell’s acknowledgement of continued tariff pressures revealed his true position. The Fed is closer to raising rates than cutting them.
The U.S. economy is now in stagflation.
During a CNBC interview last week, Ray Dalio—the billionaire investor and founder of Bridgewater Associates—said the U.S. economy has slipped into stagflation. Interestingly, Dalio also said that cutting the fed funds rate would be a mistake and, in fact, would damage the central bank's credibility.
The term stagflation was popularized in the 1970s to describe economic conditions that combine stagnation and inflation. In other words, slow or contracting economic growth accompanied by rising prices of goods and services. And, unfortunately, there's plenty of evidence for both today.
We’re all too aware of rising prices throughout the economy. Inflation is running at an annual rate of 3.3% and has been trending above the Fed’s 2% target for over 60 consecutive months, since March of 2021.
The war in Iran has shattered the stability of energy prices and is pushing prices of everything higher. Food prices are being driven higher by rising fertilizer and transportation costs. Stress across a number of supply chains is driving prices of many goods higher—and the full effects won’t be felt for another month or two. The energy shock will linger longer than most people expect. I expect inflation to hit 4% in the coming months and remain high through year-end.
There’s no question, we’ve got “flation.” There’s some debate about the “stag,” but I think when you look past the headline numbers, I think it’s clear.
According to Rosenberg Research, excluding healthcare and education 82% of the U.S. labor market is in contraction, meaning employment growth is actually negative. Outside of financial services, healthcare, and the tech capex boom, broader GDP has experienced back-to-back negative readings, indicating that three-quarters of the economy is already in a recession.
Real disposable income is flat, and consumers are heavily relying on credit and drawing down on savings. The Atlanta Fed GDP Now model has Q1 GDP tracking at an annual rate of 1.2%. The University of Michigan Consumer Sentiment Index is sitting at 49.8, a level lower than during the depths of the Great Financial Crisis and the COVID pandemic. We won’t get final revised economic data on the first half of 2026 until around year-end, but I agree with Ray Dalio. That data will show we’re in a stagflationary environment now.
Warren Buffet: “We’ve never had people in a more gambling mood than now.”
Berkshire Hathaway hosted its 2026 annual shareholders meeting over the weekend in Omaha, Nebraska. The meeting marked a significant transition, with Greg Abel, as CEO, taking over for the first time. During the lunch break, Warren Buffett was interviewed on CNBC and compared the stock market to “a church with a casino attached,” saying enthusiasm for gambling is at a peak. “We’ve never had people in a more gambling mood than now,” he said.
Buffett’s comment hit home because just a couple of weeks ago, I said the exact same thing, in my market commentary “A Gambling Mood on Wall Street.” Maybe Warren is reading my newsletter and watching my YouTube channel.
Today’s S&P 500 CAPE ratio, a measure of stock market valuation, is higher than 99% of historical valuations—driven by investors' overconfidence and FOMO, or fear of missing out.
When stock market prices reach these extreme levels, the primary concern is not necessarily an immediate crash, but rather the mathematical reality of what your investments are likely to earn over the next decade. Historically, when valuations are this high, returns over the following ten years are very low, sometimes even negative. This means that if you are relying on traditional buy-and-hold investment advice, your portfolio may be priced for a lost decade of little to no growth.
Recognizing current market conditions is the first step in protecting your wealth. To navigate this environment, your portfolio should be focused on risk-management and diversification beyond U.S. large cap stocks. At Alpha Rock, we favor asset classes like energy, infrastructure, physical assets and companies that have the pricing power to weather economic shifts.
If you’d like to see how I’m investing for my clients, download my Q2 Investment Outlook: The End of Easy Money.
THE ALPHA ROCK DIFFERENCE - Our investment strategies are a compelling alternative to traditional buy-and-hold investing. By focusing on liquid alternative investments and active risk-management, we target absolute returns, not benchmarks. To see how we’re invested and why, download our most recent Quarterly Investment Outlook, The End of Easy Money.
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