Over the past several years, the central bank only had to focus on inflation. Yes, prices were high, especially in the summer of 2022, but the labor market was booming. That meant the Fed had the luxury of focusing all its efforts on one task, albeit a challenging one. 

With tariffs causing widespread uncertainty throughout the economy, the central bank may have to face both rising prices and unemployment. The real conundrum is that the solution to one usually exacerbates the other. 

As Fed Chair Jerome Powell said in his press conference Wednesday, such a scenario would force the central bank to make a “complicated and challenging judgment.” 

“We may never face it, but we have to keep it in our thinking now,” Powell said.  

When inflation rises, the Fed hikes interest rates to cool the economy. But when unemployment rises, the bank does the opposite and cuts rates to stimulate the economy. In the rare scenario where both inflation and unemployment rise, the Fed tends to have to pick one based on which of the two it believes would be easier to solve, according to Powell. 

“We would look at how far they are from the goals, how far they’re expected to be from the goals, what’s the expected time to get back to their goals,” Powell said. “We look at all those things and make a difficult judgment.”

In addition to the increased risks of rising inflation and unemployment, the U.S. also faces the prospect of lower growth. Sluggish growth paired with high rates of inflation leads to stagflation—one of the most feared words in economics. 

What is stagflation?

The U.S. suffered its most famous bout with stagflation in the late 1970s, when a surge in oil prices caused a ruinous mix of spiking inflation and rising unemployment.  Runaway price growth only came down after then–Fed Chair Paul Volcker raised interest rates to all-time highs, inducing a painful recession. Now there are fears the President might put the central bank in a similar pickle. 

“If the large increases in tariffs that have been announced are sustained, they’re likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment,” Powell said.

For now, most economic data remains strong, even as Powell acknowledged that consumer sentiment and other “soft data” measurements have plunged. But the tremendous uncertainty around trade policy is just too large to ignore, said Jamie Cox, managing partner for Harris Financial Group in Richmond, Va. 

“The Fed isn’t pulling any punches on the potential for tariffs to cause stagflation,” he said. 

Of course, what happens next is anyone’s guess. 

“If you talk to businesses or market participants or forecasters, everyone is just waiting to see how developments play out,” Powell said, “and then we’ll be able to make a better assessment of what the appropriate path for monetary policy is.” 

Fed’s soft landing in jeopardy  

When push comes to shove, many on Wall Street believe the Fed will step in when the labor market weakens and lower rates. After Powell’s press conference, traders are now pricing in three to four cuts by the end of the year, according to the CME Group’s FedWatch tool. 

“It’s going to be an interesting summer,” Greg McBride, chief financial analyst at Bankrate, wrote in a note Wednesday. 

Trump has made his preferences clear: He thinks interest rates should have come down five months ago. However, as McBride noted, the president might want to be careful what he wishes for. 

“It is tempting to romanticize the idea of lower interest rates, particularly from a borrowing perspective,” McBride said. “But the reason for lower interest rates is very important. We want interest rates to come down because inflation pressures are easing, not because the economy is weakening. Unfortunately, if rates do come down in the coming months, it is more likely because the economy weakened.”

The White House did not immediately respond to a request for comment. 

The Fed may have responded slowly when inflation reached four-decade highs late in 2021, but the central bank’s eventual rate-hike regimen seemingly reined in prices without tanking the economy. Now, Powell acknowledged, the current scope and scale of tariffs could put a so-called soft landing in jeopardy. 

“We would not be making progress toward those goals,” Powell said, “again, if that’s the way the tariffs check out.” 

Trade talks with other nations, Powell said, could substantially alter the picture. Treasury Secretary Scott Bessent and U.S. trade representative Jamieson Greer, for example, will meet with Chinese counterparts this week. 

The central bank is now at the mercy of the president when it comes to pursuing both full employment and price stability, Robert Conzo, CEO of registered investment advisor the Wealth Alliance, told Fortune. 

“The effectiveness of the Fed maintaining their path on this dual mandate,” he wrote in an email, “depends on the ability of the administration to effectively negotiate tariff deals.”