(The opinions expressed here are those of the author, a columnist for Reuters.)

By Jamie McGeever

ORLANDO, Florida, March 20 (Reuters) - The fate of U.S. financial markets this year will largely depend on whether any tariff-fueled inflation turns out to be "transitory", enabling the Federal Reserve to cut interest rates, or whether the central bank gets bogged down by the specter of "stagflation".

The first scenario is the one Chair Jerome Powell outlined on Wednesday as the central bank's "base case", sparking a powerful rally on Wall Street and a sharp drop in Treasury bond yields. So it's risk on, right?

Investors chose to ignore the second scenario, even though it is arguably the more obvious one to draw from the Fed's revised economic projections.

Policymakers are now expecting higher inflation and meaningfully slower growth. The median interest rate 'dot plot' was unchanged from December, still pointing to two cuts this year, but there's a shift underway - eight policymakers now think one cut or none at all will be appropriate this year.

So, risk off?

'Team transitory' may have stolen a march on 'team stagflation', but a lot of stars will need to align for it to emerge victorious over the long haul.

THE T-WORD

Many investors likely shuddered when Powell invoked the T-word on Wednesday, given the Fed has had to keep rates higher for longer precisely because the post-pandemic inflation surge wasn't as transitory as Powell and then-Treasury Secretary Janet Yellen had claimed.

That said, Powell is correct that the inflation caused by President Donald Trump's 1.0 trade war was transitory. Academic studies suggest the first-round impact of Trump's 2018 tariffs added up to 0.3 percentage points to core PCE inflation, but annual core PCE inflation in 2018 never exceeded 2% and fell in 2019.

Still, the Fed's credibility took a beating with the post-pandemic 'transitory' debacle, so Powell may be leaving himself and the institution open to further attacks if any future price increases prove to be stickier than bargained for.

This is a genuine risk because Trump's proposed tariffs are of a whole different order this time around. A Boston Fed paper last month estimated that the first-round impact of tariffs could add between 1.4 and 2.2 percentage points to core PCE.

This would have a much deeper and longer-lasting impact on inflation. Fed officials are wary. Not only did they raise their median 2025 inflation outlook, but some also raised their 2026 and 2027 projections, and 18 out of 19 believe price risks are still skewed to the upside.

STAGFLATION SPECTER

It's also worth noting that Fed officials lowered their growth projections significantly more than they raised their inflation outlook.

The 2025 growth outlook fell to 1.7% from 2.1%, and down to 1.8% for the next two years. Granted, that's still decent growth and nowhere near a recession, but it would mark the first back-to-back years of sub-2% expansion since 2011-12.

Moreover, 18 out of 19 Fed officials see growth risks still tilted to the downside, compared with only five in December. Even if the Fed does cut rates, it is just as likely to be in response to the economy rolling over and unemployment shooting up than anything else. Would that be 'risk on'?

While no one is talking about a return to the 1970s, stagflation risks are rising, which hugely complicates the Fed's reaction function. The bar for cutting rates is getting higher, and it is difficult to see how this creates a positive environment for risk-taking - that is, unless team transitory emerges victorious in the end.

(The opinions expressed here are those of the author, a columnist for Reuters.)

(By Jamie McGeever; editing by Diane Craft)