America is dangerously close to the worst kind of recession

I do not envy Federal Reserve Chairman Jerome Powell right now.

The 72-year-old former investment banker and longtime economic policymaker stands at a precarious crossroads. As the Fed chairman, his job is to achieve two goals: price stability and full employment. Usually, the trade-off between these two aims is clear, but these days, Powell has to perform a difficult balancing act. On the one hand, he needs to keep prices in check as the White House enacts dramatic tariffs on our biggest trading partners. On the other hand, he has to try to slow the uptick in the number of jobless Americans.

How Powell addresses this conundrum will have massive effects on the American economy. Get it wrong and the US could get stuck in the dreaded "stagflation," a condition in which inflation is taking off at the same time the job market is getting weaker. It's nearly impossible to simultaneously address the "stag" and the "flation." Policymakers obviously care about both sides of the dual mandate, but given the central bank's blunt tools, equal treatment by the Fed isn't really possible.

This leaves investors in a pickle. Over the past two decades, the stock market's playbook has been fairly obvious: Don't fight the Fed. As the Fed has become more willing to step in and backstop the economy, it's gained the power to stem even the harshest stock sell-offs. Its track record is impressive, too. Seven of the last eight bull markets — when major stock indexes rallied at least 20% — started when the Fed was cutting rates. Investors eventually picked up on this, snatching up stocks as soon as policymakers intervened.

But what do you do when even the Fed isn't sure what side it's on?

So far, Powell and his compatriots at the Fed have chosen to do nothing. They're taking the wait-and-see approach, hoping that clear trends — or a way out of tariff threats — will arise in the coming months. I have no answers for this predicament, and as I said, I certainly wouldn't want to be in the chairman's shoes right now. But I do think this moment requires us non-Fed members to think differently about our own money.

Understanding history is important when we're talking about the Fed's current rock-and-a-hard-place situation.

For decades after its creation in 1913, the Fed was the invisible hand on Wall Street, guiding interest rates through booms and busts without noise or fanfare. Central bankers were tasked with ensuring the stability of the banking system, with a few unofficial projects around keeping prices stable that were more extra credit than required homework. The Fed's job changed drastically in the 1970s, though. In an era of disco balls and poofy hair, the US economy battled one of its toughest tests to date — an inflationary shock from a surge in oil prices, and an unemployment rate as high as 9%. This is the infamous stagflation crisis, and it was the height of economic misery.

The basic problem with stagflation is that it's an incredibly difficult trap to climb out of. Corporate America is suffocated by higher costs and lower revenue. Businesses respond by cutting jobs, and as many Americans lose their primary source of income, they spend even less. Affordability suffers when things are getting more expensive, and as unemployment rises, people have less bargaining power to request raises, making inflation cut even deeper. It's a nasty cycle that feeds on itself.

It also creates a rough situation for the Fed. The central bank can try to influence the economy in a few ways, but the most important is its power over interest rates — the cost for banks, businesses, and even average Americans to take out loans. Raising interest rates is supposed to address inflation, and in scenarios when inflation has been the clear issue, the Fed has usually responded that way. But with stagflation, rate hikes can crush businesses' profit margins and increase Americans' borrowing costs through higher mortgage and auto loan rates. Then, everyone spends less money, and the vicious cycle continues.

The Fed took several years to get the 1970s crisis under control, with Fed Chairman Paul Volcker ultimately delivering the decisive blow through a steep and painful period of interest-rate hikes. He figured that crushing the "flation" would then give the Fed room to deal with the "stag." Though the Fed ultimately emerged stronger, with its dual mandate legally enshrined, the period also left deep scars on the psyches of central bankers and Wall Street economists alike — many of whom are still around today. So it's no surprise that the glaring similarities between our current environment and the 1970s period have caused quite a bit of consternation. This is especially troubling for Powell, who counts Volcker, the stagflation slayer, as his central banking hero.

Similar to 50 years ago, an exogenous inflation shock is working its way to our wallets, this time through tariffs. Dramatic tariffs threaten to boost prices on a wide range of products, and like the 1970s, it's unclear how long these higher prices could stick. Yale's Budget Lab estimates this could cost households $3,800 this year. The president is launching this trade war at a time when consumers are already in a weakening position: Economic growth projections from the Atlanta Fed's GDPNow estimate that first-quarter consumer spending stagnated.

The concerns about stagflation are also acute because the inflation crisis of 2022 looms large in the Fed's mind. One-third of the Fed's current voting members were behind the decision to keep interest rates low through 2021 as bond markets sounded the alarm over inflation. While Powell and company are determined to get it right this time, they are also aware of the pickle: Ninety-eight percent of Fed members said in March that higher inflation is a bigger risk going forward than deflation, while 95% cited higher unemployment as the prevailing risk in the job market.

For investors, stagflation also presents some nasty possibilities. Prices rise and revenue slows. People flee the stock market because companies can't maintain profit margins. They also shun bonds because fixed income often can't keep up with the pace of price increases. Tangible assets like gold and oil turn into safe havens, but even their values are roiled by violent changes in supply and demand. You can't find anywhere to hide.

We live in stressful times, so let me offer you some comforting words. Reciprocal tariffs have effectively frozen consumers and businesses alike. It's possible we're in a recession right now. But a sudden shock could mean some important counterbalances are at play. There's a chance that retailers and factories won't be able to pass along these costs to consumers because demand is already sliding.

If prices can't go up, that could head off any increase in the rate of inflation. That dynamic is why actual stagflation is rare — as in four quarters in the last 55 years rare. The "stag" often takes care of the "flation."

What I do worry about, though, is the Fed's inability to react to economic weakness or surging inflation. In an ideal world, the Fed should be able to proactively balance the economy and protect against future risks. A year ago, this ideal world was within reach. The Fed started lowering interest rates in September, even though unemployment was historically low — a nod to a victory over COVID-era inflation. The S&P 500 jumped 20% for two consecutive years, in part because policymakers were able to effectively steer through the rough waters.

This isn't the case anymore. The Fed is in a reactive position. It can't risk taking action to get ahead of potential tariff inflation for fear of hurting the labor market, and it can't provide confidence-boosting interest-rate cuts for fear of reignited price hikes. Powell's hands are tied. In the absence of a central bank response, Americans could look to the federal government to try to ease some of the job market concerns. But given that the Trump administration is hell-bent on cutting costs and government headcounts, it's unlikely that avenue of relief is available.

It's not a stretch to think that markets may be on their own to absorb any extreme changes in economic conditions. For you, that means potentially steeper ups and downs in the stock and bond markets. We've already gotten a taste of that recent, as investors were forced to deal with some of the most volatile weeks in history for stocks and yields.

As investors, our job is to take measured risks with our money to build wealth over time. Many people do this best by taking a largely passive approach: tossing a set amount of money into the stock market on a set schedule, not buying or selling on every Fed headline or speaker comment. However, we are humans, not AI-powered robots. We can't always keep our emotions in check when markets are swinging. If the Fed is frozen, we have to take it upon ourselves to set an investing plan and do everything we can to stick to it.

Fed policy also has a big influence on how we experience our lives, even if we're just casual observers of market headlines or occasional index fund dabblers. The Fed controls affordability — do you have cash in a savings account? The Fed's decisions could impact the rate you make relative to inflation. Are you in the market for a new house? The Fed's policy could indirectly impact long-term interest rates, which feed into those sky-high mortgage rates.

You are not powerless in this situation. Stocks are your best tool for fighting inflation over time — the S&P 500 has beaten inflation in five out of the last seven decades. Many of us can afford to take a longer perspective because we're investing for goals decades ahead. While it may look gnarly now, historically, the resiliency and overperformance of the American economy would suggest that buying US stocks when they are this deep into a sell-off will pay off.

We don't know where the Fed will land yet, or if Powell will slip off this nerve-racking policy tightrope. But as we process a lot of conflicting and unusual economic forces, remember what's at stake right now. Your buy-the-dip reflex can work in this environment, you may just have to wait longer for it to play out.

Callie Cox is the chief market strategist at Ritholtz Wealth Management and the author of OptimistiCallie, a newsletter of Wall Street-quality research for everyday investors. You can view Ritholtz's disclosures here.