This article explores how a possible stagflation in the United States could influence US markets and, subsequently, Indian markets.
Understanding stagflation and risks
Stagflation is a condition where inflation rises even as economic growth remains sluggish or stagnant, often accompanied by rising unemployment. Unlike demand-driven inflation, which typically results from increased consumer spending, stagflation usually stems from supply-side shocks or external disruptions.
One of the most notable episodes of stagflation occurred in the US during the 1970s. Following the 1973 Arab-Israel war, Arab OPEC countries imposed an oil embargo on the US, triggering a surge in oil prices. This fuelled inflation and crippled the oil-dependent US economy, pushing it into a slowdown. Unemployment rose alongside inflation, which peaked at 14% in 1980. The US Federal Reserve, under Chairman Paul Volcker, had to raise the federal funds rate (the benchmark interest rate) to as high as 20% to rein in inflation.
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Currently, the US economy appears vulnerable to stagflation. Several factors contribute to this risk:
Rising import tariffs:
Proposed higher tariffs—particularly on Chinese goods—could inflate the cost of imported items. Since the US economy is consumption-driven and heavily dependent on imports, this poses a serious inflationary risk. Notably, The Economist reports that nearly 70% of products sold on Amazon US are made in China. A steep rise in tariffs could significantly push prices upward.
Income erosion and demand slowdown:
As import prices rise, real incomes—adjusted for inflation—shrink, reducing consumers’ purchasing power. With weakened demand, businesses may cut jobs, pushing up unemployment.
Economic indicators flashing red:
Recent US data shows jobless claims at their highest levels in over three years. Inflation remains around 2.4%, just above the Fed’s target of 2%. Moreover, the US economy contracted by 0.5% in Q1 of 2025, signaling a slowdown.
Why the Fed is holding back on rate cuts
The risk of stagflation is shaping the US Federal Reserve’s current strategy. Chairman Jerome Powell has indicated that interest rate cuts will be paused to better assess the combined impact of tariffs and inflationary trends. The Fed wants to avoid fuelling further inflation while monitoring signs of an economic slowdown.
What this could mean for US stock markets
A stagflation scenario could have profound effect on US equity markets. Historically, such periods have led to sharp declines in stock indices such as the Nasdaq, Dow Jones, and S&P 500—especially in overvalued sectors. Currently trading near all-time highs, these indices could experience significant corrections if stagflation materializes.
However, given the US economy’s fundamental strength, policymakers—through coordinated fiscal and monetary measures—may attempt to control inflation without derailing growth. Such measures could include reducing tariffs and deploying targeted stimulus. The impact of these measures may increase market volatility too.
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How Indian markets could feel the heat
India’s trade relationship with the US makes it susceptible to global economic shifts. The US is India’s largest trading partner, with Indian companies across sectors—IT, pharmaceuticals, auto parts—highly dependent on the US market.
Export headwinds:
Indian exports, particularly in IT and pharmaceuticals, may suffer as US consumer demand shrinks under inflationary pressures.
GDP slowdown risk:
With net exports forming a key component of India’s GDP, a US-led demand dip could weigh on overall growth.
Sentiment and stock market impact:
Increased global volatility and concerns about export earnings may drag Indian equities lower, especially in US-facing sectors.
While a stagflation scenario in the US is clearly not favourable for Indian markets, investors should remain alert to these macroeconomic developments. Defensive, non-cyclical sectors—like FMCG—may offer relative safety during turbulent times. In contrast, sectors more reliant on US demand could prove vulnerable.
Conclusion
The potential onset of stagflation in the US presents a complex challenge with significant implications for global markets and India. Policymakers in the US will need to carefully balance measures to control inflation without stifling growth. For India, maintaining economic resilience will depend on diversifying export markets and strengthening domestic demand amid global uncertainties.
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In essence, vigilance, proactive policy responses, and export market diversification strategies will be key to navigating the uncertain terrain ahead.
Dhiraj Reli, MD & CEO, HDFC Securities