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(Bloomberg) — A string of recent US data showing resurgent inflation and slowing activity is stoking fears the world’s biggest economy could be heading toward a period of stagflation. 

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Consumer spending fell by the most in nearly four years in January after a robust holiday season. Americans are growing more pessimistic about the economic outlook, and companies are warning of higher prices in the wake of the Trump administration’s aggressive tariff policy. 

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Economists caution against making too much of one month’s data, especially when skewed by factors like freezing weather. But should the risk of stagflation — or when an economy faces both tepid growth and elevated inflation — turn to reality over the coming months, the Federal Reserve would face a tough choice between supporting the labor market or finishing its years-long inflation fight.

“There’s a slight smell in the air of stagflation,” said Gregory Daco, chief economist for EY. But “we’re not there yet.”

“Developments, especially this past week, have shown that sentiment measures are softening, that spending is also softening and that inflation fears — at least inflation expectations — are on the rise,” he said.

Much of the blame for the souring mood is being placed on President Donald Trump’s economic agenda. That includes punitive tariffs on the nation’s largest trade partners and his vow to make big public-spending cuts — a move that has led to layoffs among federal workers.

As of now, the most concerning signals stem from surveys of expectations and sentiment. 

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A gauge of consumer confidence fell in February by the most in almost four years, reflecting a broad-based decline across age groups and incomes. Inflation expectations over the coming year increased to the highest since 2023, reflecting the recent jump in the cost of eggs as well as anticipated higher prices from Trump’s planned tariffs. 

Business activity, meanwhile, expanded this month at the slowest pace since September 2023, dragged down by the service sector, while retail sales slumped in January by the most in nearly two years. And the Atlanta Fed’s latest GDPNow forecast shows economic activity contracting in the first quarter — though the early estimate is subject to fluctuations over the coming months.

“If consumer sentiment drops, at some point you start to worry that consumption is actually next,” said Ajay Rajadhyaksha, global chairman for research at Barclays Plc.

Businesses big and small are also warning about what’s ahead. 

Ford Motor Co. Chief Executive Officer Jim Farley said the 25% tariffs proposed on Canada and Mexico would “blow a hole” in the US auto industry. And Chipotle Mexican Grill Inc. cautioned about potential tariffs on food like avocados and limes.

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Smaller businesses, meanwhile, have reported freezing expansion plans, hiking prices and concerns about their bottom line. Almost 60% of US adults expect Trump’s tariffs will lead to higher prices, according to a Harris Poll conducted for Bloomberg News.

That gels with Arin Schultz, chief growth officer at Naturepedic, which makes organic mattresses in Cleveland, Ohio. The company just had its best year amid robust consumer demand, but new tariffs on the material he sources from overseas would have an impact. His plea to the new administration: lay off on duties for materials that aren’t economically viable to make in the US.

“A decent amount of our components are just not made in the US. Even if they were, I think the cost of sourcing everything here domestically would drive up our costs,” Schultz said. 

Fed Impact

Treasury yields have tumbled sharply from this year’s peak reached just before President Trump’s Jan. 20 inauguration, and bond investors have begun to price in that the Fed will have to pivot from worrying so much about inflation to more concerns about growth.

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Fed officials are beginning to acknowledge the possibility that growth could falter while inflation is still high. Such a situation has long haunted central bankers, who seek to keep prices in check and maximize employment. 

It pits those two goals against each other: Lower rates to support the labor market and risk stoking inflation. Keep rates high to stifle price growth, however, and the economy could tip into recession.

If history is any guide, the Fed would act aggressively to bring prices and expectations of future inflation in check. In the 1970s and 1980s, that meant raising interest rates to eye-wateringly high levels that, in turn, drove up unemployment and caused a lot of economic pain. 

This time around, the Fed has substantially cooled inflation without causing a recession, in large part because inflation expectations have stayed low. With those increasing now, the Fed may be forced to keep borrowing costs high even if weaknesses emerge in the economy.

“They may have been slow on the uptake in raising rates this last time, but stagflation is a whole other ball game for the Fed,” said Diane Swonk, chief economist at KPMG. “They cannot allow something like that to take hold.”

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Trump has promised that his policy mix of lower taxes, deregulation and higher tariffs will unleash a wave of investment across the economy. Trump’s pick to chair the White House Council of Economic Advisers, Stephen Miran, told lawmakers Thursday the country can have a “fabulous economy” even with high tariffs.

Yet for now, businesses are worried.

“If prices go up for us, prices go up for our customers,” said J.D. Ewing, who runs Pennsylvania-based office-furniture wholesaler COE Distributing. “There is a need to fully understand that. If it is a broad brush implementation, there is no choice, costs have to go up for everyone.”

—With assistance from Jonnelle Marte and Liz Capo McCormick.

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