Federal Reserve Chair Jerome Powell last week firmly dismissed the idea that stagflation poses a threat to the U.S. economy. However, as Wall Street economists significantly raise their probability assessments for a U.S. recession due to the war with Iran and persistent inflationary pressures, his successors may face considerably more difficult policy challenges.

Economists are markedly increasing their recession risk assessments. In recent days, due to a significant rise in geopolitical risks and ongoing signs of stress in the U.S. labor market over the past year, economists have boosted their estimates for the risk of an economic contraction.

Moody's Analytics has raised its model's probability of a U.S. recession within the next 12 months to 48.6%. Goldman Sachs has increased its probability to 30%, Wilmington Trust estimates 45%, and EY Parthenon estimates 40%, specifically cautioning that "these probabilities could rise quickly if the Middle East conflict lasts longer or becomes more severe."

During normal times, the baseline risk of a recession within the next year is approximately 20%. While current forecasts are far from certain, they clearly reflect a significant increase in risk levels. This situation presents a serious challenge for policymakers, who must balance threats to the labor market against stubborn inflationary pressures.

Mark Zandi, Chief Economist at Moody's Analytics, stated, "I am concerned that recession risk is at a uncomfortably high level and is still rising. A recession has become a real threat here."

The prolonged war with Iran is a primary driver behind the increased discussion of a potential U.S. economic contraction. Since the Great Depression, nearly every U.S. recession has been preceded by an oil shock, with the exception of the COVID-19 period.

According to AAA data, U.S. gasoline prices have risen by $1.02 per gallon over the past month, a 35% increase. While economists debate the pass-through effects of higher energy costs, historical patterns suggest this trend can be persistent.

Mark Zandi noted, "The negative impacts of high oil prices tend to arrive earliest and fastest. If oil prices remain at current levels through Memorial Day, or even through the end of the second quarter, we would likely tip into a recession." Like most forecasters, Zandi added that his "baseline scenario" still anticipates that involved parties will find a diplomatic solution, restoring oil flow through the Strait of Hormuz and allowing the U.S. economy to avoid the worst outcome.

Beyond energy prices, economists point to the labor market as another critical pressure point. The U.S. added only 116,000 jobs for the entirety of 2025, with a net loss of 92,000 jobs in February. While the unemployment rate remains stable at 4.4%, this is primarily due to fewer layoffs rather than a significant increase in hiring.

Furthermore, the breadth of hiring in the labor market is exceptionally narrow. Excluding the over 700,000 jobs added in the healthcare sector, employment in other industries has actually decreased by more than half a million over the past year.

Luke Tilley, Chief Economist at Wilmington Trust, said, "I believe inflation risks are much lower than Fed officials think, while the downside risks to the labor market are much higher than they are stating." Dan North, Senior U.S. Economist at Allianz, added, "The need for healthcare for a growing aging population will persist. But if the entire economy is running on just one engine, that is simply not sustainable."

Employment is a key driver supporting consumer spending. Despite concerns about rising prices and economic growth, U.S. consumer spending has remained relatively strong so far.

These dual pressures have revived discussions of "stagflation," a combination of high inflation and slowing economic growth that severely troubled the U.S. in the 1970s and early 1980s. At a press conference following last week's Federal Reserve policy meeting, where the central bank held its benchmark interest rate steady in the 3.5%-3.75% range, Powell explicitly rejected the term.

Powell stated, "I should point out that stagflation is a term from the 1970s, when unemployment reached double digits and inflation was also very high. The situation now is completely different." He added, "The current situation is certainly very challenging, but it is nothing like the 1970s... I reserve the term 'stagflation' for that period. Perhaps that's just my personal view."

The current U.S. economic condition might be described as "mild stagflation," less severe than the 1970s but still posing significant risks. Overall consumer confidence is low, with middle- and lower-income groups facing greater pressure from high prices.

Luke Tilley of Wilmington Trust warned that recent consumption growth has relied heavily on wealth effects from rising asset prices, a dynamic that may be unsustainable. He said, "We estimate that 20% to 25% of consumption growth over the past two years came from wealth effects generated by the stock market. If that wealth effect boost disappears, economic growth would slow significantly."

Indeed, U.S. stock performance has been weak since the war began. The Dow Jones Industrial Average has fallen more than 5% during the conflict. This pressures consumption and confidence, as higher-income groups, whose spending significantly impacts the overall economy, are the primary beneficiaries of stock market gains.

According to the Atlanta Fed's GDPNow model, first-quarter U.S. GDP growth is estimated at 2%, but this follows a low base of just 0.7% growth in the fourth quarter of 2025, partly impacted by a government shutdown. Economists had expected a compensatory rebound in the first quarter, but the effect appears limited.

However, if global leaders can end the war promptly, the U.S. economy may still avoid the worst predictions. The large-scale legislative package passed in 2025 is expected to provide economic stimulus, including reduced regulatory burdens and increased tax rebates to help consumers cope with high prices. Additionally, a continued rebound in productive activity remains a favorable factor.

Dan North, Economist at Allianz, said, "There is still underlying support for the economy, which makes me very cautious about using the word 'recession.' But I do believe the U.S. economy is slowing noticeably this year."

Overall Outlook: While Fed Chair Powell continues to dismiss stagflation risks, Wall Street forecasters have significantly raised their recession probabilities, reflecting how geopolitical uncertainty from the Iran war combined with domestic labor market weakness poses a substantial threat. Whether the U.S. economy achieves a soft landing will depend on the duration of the Middle East conflict, the trajectory of oil prices, and the Fed's ability to balance its policy between fighting inflation and supporting employment.

For investors, maintaining caution is advised, focusing both on signals from Federal Reserve policy and closely monitoring developments in the Middle East situation.