Last week, Federal Reserve Chairman Jerome Powell pushed back when asked whether stagflation posed a threat to the U.S. economy. His successor could face even tougher challenges, with Wall Street forecasters raising expectations for a recession, due in part to the possibility of a war with Iran and higher prices.
Economists have raised their risk assessments for a U.S. recession in recent days amid heightened uncertainty over geopolitical risks and a labor market that has been tense over the past year.
Moody’s Analytics model has raised its forecast for a recession over the next 12 months to 48.6%. Goldman Sachs raised its forecast to 30%. Wilmington Trust has odds of 45% and EY Parthenon has odds of 40%, but warns that “odds could rise rapidly if the Middle East conflict becomes more prolonged or severe.”
In normal times, the risk of a recession over a 12-month span is about 20%. Therefore, although the current forecast is not certain, it does represent an increased risk.
The situation poses a tough challenge for policymakers, who must balance threats to the labor market with persistently high inflation.
“We’re concerned that recession risks are uncomfortably high and rising,” said Mark Zandi, chief economist at Moody’s Analytics. “Recession is a real threat here.”
war drives fear
As the war with Iran drags on, talk of economic contraction is accelerating.
The oil crisis has preceded virtually every recession the U.S. has experienced since the Great Depression, with the exception of the coronavirus pandemic. According to AAA, pump prices have increased by $1.02 per gallon over the past month, an increase of 35%.
Economists still debate the effects of high-energy pass-through, but the trend holds.
“The negative effects of high oil prices will occur first and quickly,” Zandi said. “If oil prices stay at these levels through Memorial Day and certainly through the end of the second quarter, we will be in a recession.”
Zandi, like other forecasters, said his “baseline” prediction was that the warring sides would find a diplomatic outlet, oil would flow through the Strait of Hormuz again, and the economy would avoid the worst-case scenario.
Indeed, many economists are in denial, stuck in the old metaphor of predicting nine out of the last five recessions. Markets also have the wrong idea of where the economy is headed. The part of the yield curve that the Fed watches most closely — the spreads between maturities of various Treasury bonds — has repeatedly sent false recession signals for most of the past three-and-a-half years.
But the lingering threat of war, consumer pressures that drive more than two-thirds of total growth, and a labor market with virtually no jobs created by 2025 collectively raise the risk that expansion will stall.
“The road is getting narrower and narrower, and it’s getting harder and harder to see the other side,” Zandi said.
Consumers are also pessimistic. According to consumer site NerdWallet, 65% of respondents in a March survey expected an economic recession in the next 12 months, up 6 points from the previous month.
work worries
Economists say that apart from energy prices, the labor market is another key pressure point.
The U.S. economy added just 116,000 jobs in all of 2025 and lost 92,000 jobs in February. The unemployment rate is stable at 4.4%, but this is largely due to a lack of layoffs rather than a surge in hiring.
Furthermore, the labor market suffers from a narrow range of employment opportunities. Excluding the large increase in healthcare-related fields (more than 700,000 jobs overall), employment outside these fields has declined by more than 500,000 people over the past year.
“I think the inflation risks are much lower than[Fed officials]think and the downside risks to the labor market are greater than they’re saying,” said Luke Tilley, chief economist at Wilmington Trust.
“More people are going to need more health care in the future,” added Dan North, senior U.S. economist at Allianz. “There’s always going to be demand for these jobs, but you can’t run a railroad if you’re running a railroad with one engine.”
Of course, employment is the main driver of consumer spending, and consumer spending has remained strong despite concerns about rising prices and growth.
These two concerns have spurred debate about stagflation, the combination of high inflation and slowing growth that plagued the United States in the 1970s and early 1980s. Fed Chairman Jerome Powell rejected this characterization in a press conference after last week’s policy meeting, in which the Fed kept its benchmark interest rate in the range of 3.5% to 3.75%.
“I always have to point out that this was in the 1970s, when unemployment was in the double digits and inflation was very high.” “Not now.”
“It’s a very difficult situation, but it’s not like the situation they faced in the 1970s. I reserve the word stagflation for that period. Maybe it’s just me,” Powell added.
cracks in the foundation
Therefore, the current situation may be closer to stagflation. Although this condition is less pronounced than previous episodes, it still poses a risk. Consumer sentiment is generally poor, with people in the lower income brackets, who have been particularly hard hit by rising prices, restraining their spending.
Wilmington Trust’s Mr. Tilley cautioned that spending is largely supported by rising asset prices, and that momentum may not be sustained.
“Over the past two years, we estimate that 20-25% of spending growth has been driven by wealth effects from the stock market,” he said. “If we don’t drive the wealth effect, we’re going to lose out on a lot of the growth.”
In fact, stock prices were in a difficult situation during the war. of Dow Jones Industrial Average During hostilities it fell by more than 5%. This is important because consumer spending and sentiment have been supported by high-income households, which have benefited most from rising stock prices.
Dow since the war began
Gross domestic product is on track to grow at a 2% pace in the first quarter, according to the Atlanta Fed’s GDPNow tracking data. However, this was only a 0.7% increase in the fourth quarter, which was also affected by the government shutdown. Economists had expected a decline in growth in the fourth quarter to provide a boost in the first quarter, but the impact appears to have been modest.
Still, if world leaders can end the war soon, the economy is expected to once again avoid the gloomiest predictions. The 2025 One Big Beautiful Bill stimulus package is expected to provide significant growth, with deregulation and increased tax rebates to help consumers cope with rising prices. A sustained increase in production is also a factor boosting the economy.
“There’s underlying support,” said North, the Allianz economist. “So I’m really hesitant to use the ‘R’ word. But certainly, I think we’re going to see a slowdown this year.”
