The Stagflation Moment: Sticky Inflation, a Hawkish Bond Market, and Where the Fed Goes Next

This is the week the analytical framework we have been building over the past five weeks meets the data. UK unemployment is at 4.9 percent on the headline, but the drop from 5.2 percent has been driven by rising inactivity rather than job creation, which masks underlying labour market weakness. US unemployment is climbing toward 4 percent. US CPI on Tuesday could come in close to 4 percent, driven by the energy shock that has now run for ten weeks. Brent rallied to $105 in Asian trading after Donald Trump rejected Iran's latest peace proposal on Sunday. Friday is Jerome Powell's final day as Chair of the Federal Reserve. Kevin Warsh takes over the next day. 

This is the stagflation moment we have been writing about across the Market Insights series. The macro picture has caught up with the analytical framework. The combination of weakening growth, sticky inflation, and a central bank transition landing into a politically charged environment is exactly what we flagged in the Three Central Banks Week piece. The piece argued that the press conferences would matter more than the decisions, and that the path forward would be set by how each central bank navigated the energy shock. That is now playing out. 

This piece does two things. First, it sets out where the data has shifted in ways that matter for our public calls. Inflation is leaking into the broader data and the energy shock is proving stickier than we assumed a month ago. Second, it updates our Fed timing call from September to December, anchored on the structural framework that still holds. The near-term implication is that the dollar may strengthen further as the market prices inflation persistence, even as the medium-term case for weakness remains intact. 

What the Data Is Telling Us 

The US labour market is the clearest dovish signal in the data. The unemployment rate is climbing toward 4 percent, with long-term unemployment now at 25 percent of the total. Real wages fell 0.6 percent in March as price rises outpaced pay. Hiring momentum has slowed materially through April. The story underneath the headline is an economy losing labour market tightness, which in any normal cycle would be supporting cuts already. 

But headline inflation is heading the wrong way. The April CPI print lands Tuesday. The consensus is around 3.5 to 3.8 percent, but the energy shock running through the year-on-year comparison means a print closer to 4 percent is genuinely on the table. Services inflation has been sticky. Core has eased slightly but not enough to give the Fed cover. 

The bond market is reading this combination as hawkish. The 2-year US Treasury yield is at 3.9243, up 4 basis points on the session and trading above the upper bound of the federal funds rate at 3.75. The 2-year is the market's cleanest read on the average Fed funds rate over the next two years, and it is currently pricing net tightening rather than easing. In other words, the market is signalling that the Fed is more likely to hike than cut from here. 

Our view is the opposite. We do not see a hike. We see one cut by December, with the labour market weakness eventually overriding the energy-driven inflation impulse as the year-on-year energy base effects roll off through the autumn. The bond market is currently weighting the inflation side of the stagflation tension. We are weighting the growth side. That is the gap between the consensus pricing and our call. 

The result is the classic stagflation dilemma. The growth signals support cuts. The inflation signals and the bond market do not. The Fed is institutionally biased toward fighting inflation when forced to choose, because the scarring from 2021 to 2022 is still recent. That bias is what is holding the Fed in its easing-bias-but-not-cutting posture, and it is what is driving the multiple dissents at the FOMC about whether to maintain that bias at all. 

Powell's term as Chair ends on Friday 15 May. Warsh takes over the next day. The signal to watch over the coming weeks is whether the FOMC, under new leadership, leans toward the December meeting or keeps options as open as Bailey has on the BoE side. The political pressure on Warsh to cut is well documented. The question is how much of that pressure translates into actual policy. 

Why We Are Moving to December 

We called September as the most likely meeting for the first Fed cut in the Beyond Hormuz piece on 21 April. We held that call through the Sterling's Opening piece, the Three Central Banks Week piece, and the post-decision recap last Friday. Goldman Sachs has now moved its call to December. Wall Street is increasingly pricing the December meeting as the more likely turning point. The structural case for one cut by year-end is intact. The timing is what is shifting. 

We are moving with the data. Our base case is now one cut at the December meeting rather than September. The reasoning is straightforward. Inflation is leaking into the broader data. With Brent above $100 and likely staying there through the summer, headline CPI will remain elevated for longer than we thought a month ago. Tuesday's print could come in near 4 percent. That gives the Fed cover to hold through September even as the labour market continues to soften. By December, the labour market data will have deteriorated further, the energy impulse will have started to fade as base effects roll off, and the case for the cut will be stronger than it is now. 

The near-term implication is that the dollar may strengthen further as the market prices inflation persistence. That is a shift from the position we held two weeks ago, when we argued the dollar would struggle to firm even on supportive inputs. The data has moved in the direction of inflation stickiness, and the dollar is likely to track that shift in the immediate term. The structural framework for medium-term dollar weakness still holds, but the path is now a Q4 to 2027 story rather than an imminent one. 

For businesses with dollar exposure to manage, the practical implication is that the timing of execution matters more than it did a month ago. Current levels still look attractive against the medium-term forecasts, but the near-term path is more supportive of dollar strength than we had been signalling. 

The Bank of England Picture 

The BoE held at 3.75 percent on 30 April with an 8 to 1 vote, Pill dissenting for a hike. Bailey pushed back against multi-hike pricing in the press conference. Markets repriced from nearly three hikes to roughly two, but the hawkish bid has continued to support sterling through early May. 

The major desks have all pushed their BoE cut forecasts further out. Goldman Sachs has revised its outlook twice in March and now expects no cuts in 2026, with the first reduction in February 2027 and a terminal rate of 3 percent by early 2027. Morgan Stanley and Standard Chartered have similarly pushed easing into 2027. The desk consensus is a hawkish hold through 2026, with cuts only beginning once the energy impulse fades and inflation moderates. 

Our view aligns with the no-hikes side of the desk consensus, and we sit closer to the Goldman view on timing than the more aggressive hike-then-cut paths that some desks held earlier in the cycle. We do not expect BoE hikes from here. The labour market is loosening, not tightening. UK rates are already restrictive at 3.75 percent against an estimated neutral of 3.0 percent. The hurdle for further hikes is higher than for the ECB, where rates are starting from a more neutral position. UK GDP for Q1 lands Thursday and will be a meaningful test of the dovish case. A soft print would support the view that the BoE eventually needs to cut. A solid print extends sterling's hawkish bid for now. 

For sterling, the implication is that the BoE's relative position remains the cleanest of the three majors. The medium-term outperformance story rests on the dollar weakening faster than the BoE eventually following the Fed lower. With the major desks now pushing UK cuts into 2027, that crossover takes longer than we had assumed in earlier pieces, but the directional call holds. 

The Political Layer 

Starmer delivered his political survival speech this morning. He committed to "face up to the big challenges," promised to go faster on growth, defence and Europe, and made the case for a closer EU relationship. The speech did little to allay the leadership pressure. The pound was largely unmoved at 1.36, gilt yields drifted higher after the speech to 4.957 percent on the 10-year, and around 40 Labour MPs are still on the record calling for his resignation or a timetable for departure. 

The market read is that the speech has not contained the political risk. Catherine West is still threatening a formal leadership contest. Angela Rayner, Wes Streeting and Andy Burnham are circling as potential replacements. The King's Speech on Wednesday is the next test of Starmer's authority. Beyond that, the autumn Budget remains the fiscal pressure point.

The currency implication is that sterling's resilience right now reflects dollar weakness more than confidence in UK assets. Portfolio Adviser captured this morning's read precisely: the pound at 1.36 reflects "the uncertainty around the dollar more than confidence in the UK economy." If the political risk crystallises into a leadership contest through May or June, the policy uncertainty arrives at exactly the moment when the UK needs credible fiscal management. Sterling could give back gains from recent weeks faster than the underlying rate story suggests. 

The 30-year gilt yield at 5.628 percent is the cleaner measure of political sentiment than the 10-year, given the UK government issues a high proportion of long-duration debt. That level is the highest since 1998 and tells us the bond market is already pricing meaningful UK political and fiscal risk. 

What This Means for the Dollar 

The dollar's near-term path is now more supported than we have been arguing across the Market Insights series. Inflation is leaking into the data. The 2-year US Treasury yield is at 3.92, above the upper bound of the Fed funds rate, signalling that the market is pricing net tightening rather than easing. The Fed transition is resolving cleanly with Warsh confirmed and inheriting an FOMC that has reasons to hold longer than we previously thought. 

Tuesday's US CPI print is the immediate catalyst. A print near 4 percent would push the dollar higher against current levels, support the hold-longer narrative for the Fed, and accelerate the unwind of any dovish pricing that remained in the curve. A softer print would relieve some of that pressure but is unlikely to fully reverse the trend until the energy impulse fades. 

The structural case for medium-term dollar weakness still holds. The credibility pressures we have written about (Gulf swap line requests, OPEC fragmentation, Fed independence pressure under the Warsh transition) are accumulating, not fading. The petrodollar architecture is still under strain. But the cyclical supports for the dollar have strengthened, and the medium-term move is now a Q4 to 2027 story rather than an imminent one. 

For businesses with dollar exposure to sell, the practical implication is that the window for current levels is wider than we had been suggesting, but staggered execution becomes more important. Going in heavy at any single level when the near-term path is potentially higher would mean missing better entry points if the inflation pressure persists through the summer. 

What This Week Will Tell Us 

Two data points will shape the picture over the next 72 hours. 

US CPI for April lands Tuesday. Our base case is a print closer to 4 percent on the headline, with energy continuing to drag the year-on-year comparison higher. Above 4 percent makes the Fed's hold easier to defend, supports the dollar through the rate differential channel, and pushes the cut path further out. Below 3.7 percent would relieve some of the inflation pressure and reopen the conversation about the timing of the first cut. Either way, the print sets the tone for the dollar through the rest of May. 

UK GDP for Q1 lands Thursday. The consensus is for modest growth around 0.2 to 0.3 percent quarter on quarter. A weaker print supports the dovish UK case and starts the hawkish sterling pricing unwind. A stronger print extends sterling's hawkish bid for now. 

The combination matters for sterling specifically. Hot US CPI plus weak UK GDP is the worst case for GBP/USD. Soft US CPI plus solid UK GDP is the best. The dollar's path through the rest of May will be set primarily by the US print. 

What This Means for Businesses 

Three observations. 

We are moving our Fed cut call from September to December. The structural case for one cut by year-end holds. The timing is shifting as inflation proves more persistent than we assumed a month ago and the energy shock continues to leak into the broader data. The near-term implication is that the dollar may strengthen further before the structural weakness reasserts itself. 

The BoE picture has clarified. Goldman now expects the first cut in February 2027 with a terminal rate of 3 percent by early 2027. We do not expect hikes from here. The implication for sterling is that the relative outperformance story relies on the dollar weakening faster than the BoE eventually following the Fed lower, which is consistent with our framework but pushes the timing later than we had assumed. 

For businesses with dollar exposure to sell, the practical implication is that the timing of execution matters more than it did a month ago. The medium-term move is still expected. The near-term path is now more supportive of dollar strength than recent pieces have suggested. Staggered forward cover at current levels still captures the asymmetry, but going in heavy at any single level carries more risk now than it did before. 

We will be watching the US CPI print on Tuesday and the UK GDP print on Thursday carefully. The framework holds. The timing is the variable.