21 Commentary | China Has Sufficient Policy Tools to Address External Price Shocks

Why Does AI · Stagflation Risk Threaten the Federal Reserve’s Autonomy?

Recently, the Federal Reserve announced it would keep the federal funds rate target range unchanged at 3.50%–3.75%. The Middle East conflict and its impact on the Strait of Hormuz have disrupted global oil markets and may keep inflation above the Fed’s 2% target. The Fed’s post-meeting statement explicitly noted that this conflict introduces new uncertainties.

In fact, the process of cooling US inflation had already slowed significantly, and short-term inflation expectations have risen again in recent weeks. Powell acknowledged that price pressures from US tariffs are gradually transmitting to core inflation, and rising energy prices due to the Middle East situation add new upside risks. He also emphasized that it’s still difficult to determine how long this shock will last or how severe its impact will be, but its potential threat to the US and global economies should not be underestimated.

Previously, markets widely expected the Fed to start preemptive rate cuts in the first half of 2026 to counter potential economic slowdown. However, recent volatile economic data and the sudden escalation of geopolitical risks have quickly cooled this expectation. The likelihood of rate cuts in the short term has greatly diminished, and market focus has shifted to whether the US economy will fall into a “stagflation” dilemma.

Looking back to 2022, chip shortages caused a sharp rise in US auto prices, serving as an early signal of the inflation cycle. The subsequent outbreak of the Russia-Ukraine conflict triggered a global energy price spike, compounded by ongoing supply chain disruptions and overheated demand driven by US fiscal stimulus, creating a high-inflation cycle that lasted for years.

Today, the US supply side is under renewed pressure—energy prices are soaring due to Middle East tensions, and prices for key raw materials like chips are rising. Meanwhile, the price transmission from US tariffs continues. But unlike 2022, US demand has significantly cooled and does not have the same “overheating” foundation. Therefore, the possibility of a repeat of the 2022 “widespread price surge” is lower. However, this does not mean the alarm can be turned off. The current inflation pressures are set against a completely different macro environment, and the real risk lies in the formation of a “stagflation” pattern.

Previously, markets were optimistic that the recent rise in oil and gas prices was only a short-term shock, mainly because the disruption in Strait of Hormuz shipping was seen as more due to geopolitical uncertainty, with room for negotiation. But on March 18, direct attacks on oil and gas facilities by both sides in the conflict caused short-term capacity disruptions. This indicates that the actual supply gap in energy is widening, not just transportation issues.

As a result, the nature of the energy shock is shifting from “short-term disturbance” to “persistent pressure.” If US inflation rises again, the Fed will face an even more challenging situation than in 2022. Back then, rising prices coincided with strong economic growth, a booming labor market, and room for continued rate hikes. Now, the US real GDP for Q4 2025 has been sharply revised down to an annualized quarterly rate of 0.7%, far below the initial 1.4% and market expectations of 1.5%. Meanwhile, non-farm payrolls unexpectedly declined by 92,000 in February, with the unemployment rate rising to 4.4%, and data from the previous two months also revised downward by 69,000.

These data outline a typical stagflation risk pattern of “inflation rebound and growth slowdown.” This pattern not only means the window for rate cuts is closing rapidly but also risks causing the Fed to lose policy autonomy. If inflation rebounds quickly, the stock market bubbles accumulated over the past few years could suffer heavy damage. Additionally, the resurgence of inflation will further fracture the already fragile “K-shaped recovery”: asset prices falling will hit high-income groups, while middle- and low-income populations continue to bear the living pressures of rising prices, ultimately weakening the US economy’s reliance on consumption.

Globally, the impact of this energy shock on China is expected to be relatively limited. Unlike Europe, the US, and Japan, oil and natural gas account for a smaller share of China’s power structure, and China has large strategic reserves and relatively diversified and stable import sources. However, the uncertainty in commodity supply could influence domestic markets through expectations, as reflected in recent stock market volatility.

Looking at China’s past economic resilience, it has the capacity to absorb external price shocks. From a policy perspective, China also has the tools to do so. On March 18, the People’s Bank of China explicitly stated that it will continue to implement moderately easing monetary policy and firmly maintain the stability of stock, bond, and foreign exchange markets. This indicates that China has sufficient policy tools and institutional foundations to ensure economic and financial market stability.

SFC

Produced by 21st Century Business Herald 21st Century Economic Report