Fed Faces Tough Choices as Growth Slows and Inflation Rises

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With every new bit of economic data, the Federal Reserve's mission to keep inflation low and employment high at the same time looks more like a double bind.

A slew of economic data released Thursday deepened the central bank's dilemma in fulfilling its dual mandate from Congress to use monetary policy to achieve stable prices and maximum employment. Almost every needle moved slightly in the wrong direction from the Fed's perspective.

Inflation rose, remaining well above the Fed's 2% target for a fifth year, forcing households to cut back on savings. At the same time, economic growth is slowing.

The Bureau of Economic Analysis estimated that GDP grew at an inflation-adjusted rate of 1.6% in the first quarter. That was down 0.4 percentage points from its previous estimate and a slowdown from the 2.1% growth in 2025.1 The decline was largely due to a reduction in business inventories (a volatile category) and a downturn in consumer spending.

Officials at the central bank must decide whether to raise interest rates to fight inflation or lower them to help the job market and the economy if it starts to deteriorate. In recent remarks, Fed officials see greater risks to the inflation side of its dual mandate, so financial markets are pricing in rate hikes at some point before the end of the year. But Thursday's data complicated that picture.

"The economy isn’t just soft, it’s struggling. That's the clear message in the flood of economic data released today," Mark Zandi, chief economist at Moody's Analytics, wrote on social media Thursday.2

Slowing growth and rising inflation would put the U.S. economy on a path to "stagflation," in which workers face reduced employment prospects and a rapidly rising cost of living.

Zandi noted the 1.6% growth rate was especially lackluster, given that it incorporated a bounce-back from the fourth quarter of last year, when the government was shut down, which dragged down economic growth. The economy is now especially vulnerable to further energy shocks, such as if the U.S. and Iran fail to reach a peace deal that reopens the crucial Strait of Hormuz in the days ahead.

"The Iran war needs to end, and the Strait of Hormuz needs to be reopened soon, or recession will become more likely than not," he wrote.

In recent speeches, Fed officials have warned of risks to both inflation and the health of the job market. Alberto Musalem, president of the Federal Reserve Bank of St. Louis, said the Fed was well-positioned to react to either challenge.

"There is a scenario where inflation remains high; there's no disinflation in the next quarter or two. And in that scenario, the economy will probably require a hike," he said in an interview with Bloomberg Television at an economics conference in Iceland.3

"There's also a scenario where the economy weakens materially in the second half of the year because real incomes are challenged and corporate margins are challenged," he said. "In that scenario, inflation could come down. In that scenario, we would be thinking of no hikes, maybe even a cut."

A bright spot in Thursday's data was unemployment claims, which remained low, suggesting the job market is stable at least for the time being. With no mass layoffs in sight, Fed officials have mostly been focused on inflation risks, and in recent speeches have described it as the greater threat.

"I see elevated risks to both sides of our mandate, and from a risk-management perspective, I currently believe that the right course of action is to hold rates steady," Fed Governor Lisa Cook said in a speech at Stanford University on Wednesday.4 " However, I want to be clear about my risk assessment: The risks remain tilted toward higher inflation."

Cook said she still believed inflation would cool without the Fed having to raise rates and the labor market would stay afloat without help from Fed rate cuts, but that she was losing patience for inflation to come down on its own.

"After five years of above-target inflation, I am particularly attuned to the risk that elevated inflation will become embedded in price- and wage-setting behavior," she said, according to prepared remarks. "As such, I am prepared to raise rates if the expected disinflation does not appear in a timely manner."

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