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The Federal Reserve is in a tough spot following new data Wednesday reinforcing slower economic growth and higher inflation during the first quarter, a combination that may eventually force the central bank to choose between its dual goals of maximizing employment and maintaining price stability.
"It was still a stagflation warning shot over the bow of the economy," Morgan Stanley Wealth Management chief economic strategist Ellen Zentner said. "This type of data won't soothe the markets, and it won't make the Fed's job any easier."
The US economy contracted for the first time in three years to start 2025 as a surge in imports dragged down GDP and prices increased more than forecast.
Luke Tilley, chief economist at Wilmington Trust, expects the US economy to slip into a recession in the second quarter with another contraction in growth.
"I don't think that underlying demand looks all that solid," Tilley said of the first quarter data. "Demand in the first quarter looks to be driven by businesses battening down the hatches before the storm."
Read more: What is a recession, and how does it impact you?
Inflation during the first quarter also clocked in hotter than expected. The "core" Personal Consumption Expenditures (PCE) index, which excludes the volatile food and energy categories, grew by 3.5% in the first quarter.
That was above estimates for 3.2% and above the 2.6% seen in the prior quarter.
Inflation did cool, however, during the month of March as the quarter came to an end. That was before many of President Trump's tariffs had been announced. Some economists expect those tariffs to push inflation higher.
"Core" PCE in March increased 2.6% year over year — a step down from 2.8% previously and in line with expectations. Month over month, the metric increased less than 0.1% from February.
Headline PCE increased 2.3%, while month-over-month PCE actually fell less than 0.1%.
Read more: What is GDP, and why is it important to economists and investors?
'Challenging scenario'
The economic data from the first quarter reinforces the "challenging scenario" for the months ahead, as outlined by Fed Chair Jerome Powell in a speech earlier this month.
Powell said on April 16 that the central bank may find itself between a rock and a hard place, where its dual mandate to keep inflation stable and employment high are at odds as the president's tariffs push up prices while also lowering growth.
"We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension," he said. "If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close."