Trump's fight with the Federal Reserve escalates! Wall Street warns: The likelihood of US stagflation is increasing.

The US economy appears to be one step closer to a worst-case scenario.

Komal Sri-Kumar, president of Sri-Kumar Global Strategies, a US macroeconomic consulting firm, blames this on President Trump's recent escalation of his conflict with the Federal Reserve, including his attempt to fire Fed Governor Lisa Cook on Tuesday (August 26).

Sri-Kumar said the likelihood of stagflation is now higher. Stagflation is a dire situation in which inflation rises while economic growth slows.

He pointed to the recent rise in long-term US bond yields, which he believes indicates that investors are preparing for higher inflation in the future. He said that with signs of economic weakness, a stagflationary situation is brewing.

The overwhelming consensus is that removing Cook—something with little historical precedent—will further undermine the Fed's independence. Sri-Kumar said the market will resist any further developments surrounding Cook's removal by selling bonds and pushing up yields, which is effectively the opposite of what Trump wants.

"We are heading towards stagflation, where a recession is accompanied by significantly higher inflation," Sri-Kumar said. "What could prevent this? An immediate change of policy. Going back to the old ways and making the Fed independent. But we don't see any prospect of that happening."

The Bond Market Has Already Sounded a Warning

Stagflation is generally considered a more difficult problem for policymakers to address than a traditional recession. This is because, hampered by rising inflation, the Fed cannot lower interest rates to boost the economy as it would in a typical downturn.

The bond market has already signaled caution, with the 30-year Treasury bond yield surging on Tuesday (August 26).

In Sri-Kumar's view, rising long-term Treasury yields signal higher inflation expectations and risks to economic growth.

When long-term Treasury yields rise, it signals that investors lack confidence that inflation is stable, leading them to factor in rising long-term interest rates.

Sri-Kumar said this explains why long-term Treasury yields jumped when the Federal Reserve began its rate-cutting cycle last September. He called the move a "serious mistake."

Furthermore, long-term Treasury yields are tied to borrowing costs across the economy, such as mortgage rates. From this perspective, rising yields could affect economic activity as funding becomes tighter.

Sri-Kumar also identified several scenarios that could trigger a rise in long-term Treasury yields.

1. Lisa Cook is ultimately fired. Economists believe such a move could undermine the Fed's credibility and its ability to control inflation.
2. Trump replaces more regional Fed presidents. Sri-Kumar added that if the president brings more dovish policymakers to the Fed, it could put more pressure on the central bank to ease monetary policy. Such a move could raise market concerns about runaway inflation.
3. The Fed cuts interest rates in September despite rising inflation. Sri-Kumar said that if the Fed's preferred inflation indicator, personal consumption expenditures (CPI), comes in higher than expected, meaning the Fed cuts interest rates in September as expected, this could also push long-term Treasury yields higher.

Economists have been warning about the risk of stagflation for months, particularly as Trump's tariffs loom over the US economy. Tariffs are believed to raise consumer prices while hindering global trade, potentially hurting economic growth.

Sri-Kumar himself has been warning about the risk of stagflation for the past few years. In February of this year, months after the Fed began its rate-cutting cycle, he said he believed the Fed should continue raising rates to control inflation.