Two economic reports have brought back a word that no central banker wants to hear: stagflation.
The difficult scenario occurs when inflation rises and growth stagnates, a dangerous combination that the U.S. economy has just experienced.
Concerns arose when the first quarter GDP figure released on Thursday fell short of expectations, with annualized growth of 1.6%. This is a considerable slowdown from previous quarters and well below estimates of 2.5%.
A day later, personal consumption spending did the opposite, beating Friday’s forecast. The inflation indicator, favored by the Federal Reserve, increased by 2.8% against a consensus of 2.7%.
“If you compare the inflation report with yesterday’s GDP report, I think investors really need to start positioning themselves for the resurgence of the stagflation debate,” said Jeffrey Roach, chief economist at LPL Financial, to Business Insider.
If this were to actually come to fruition, it would not be a welcome sight for the markets.
Lessons can be learned from the 1970s, a decade often cited as a warning. At that time, a cycle of low growth and double-digit inflation ended only after the Fed pushed interest rates to sky-high levels, plunging the United States into a recession. When the problems first emerged, volatility sent stock markets tumbling.
To be sure, stagflation is not Roach’s base case scenario, as he and other analysts will want to see more data before making such a decision.
“It really depends on the inflation part of the equation, and whether that forces the Fed to keep the bar higher for longer,” Mike Reynolds, vice president of investment strategy at Glenmede, told BI. He also noted that he had recently become more attentive to the risks of stagflation.
“A few Fed officials are floating the idea of possible additional rate hikes – that’s not the consensus – but the fact that we’re talking about it now is kind of indicative of the situation we find ourselves in,” Reynolds said.
Among the most prominent voices on Wall Street currently warning of stagflation is JPMorgan CEO Jamie Dimon, who has frequently referenced the 1970s to explain why markets shouldn’t get too comfortable with the current economy:
“I point out to a lot of people that things looked pretty rosy in 1972 — they didn’t look rosy in 1973,” he recently told the Wall Street Journal, warning that a downturn could come in the next two years, in a context of increasing inflation.
In the event that monetary policy is forced to remain higher this year, Roach and Reynolds agree that the consequences could occur as early as 2025.
According to Reynold, any fallout would be delayed by election-related fiscal measures, although that would only add to inflation, thus worsening the Fed’s options.
Meanwhile, in 2025 and 2026, the government and businesses will roll over their debt, Roach said, adding that if rates remain high, it will only increase the risk of something breaking.
To protect against any rise in risks, Reynolds suggested slightly underweighting stocks. He said this could be offset by additional exposure to fixed income, although investors should not overexpose themselves to duration, as the risk of future inflation could cause rates to rise, weighing on long-term assets. long term.
Alternative investments could counter any disappointment in bonds or stocks, Roach said.
But for now, stagflation is only a distant possibility, and the threat could diminish with future reports or a GDP revision, both experts note.
On Friday, Bank of America opposed this scenario, citing no signs of stagflation. Echoing Reynolds’ arguments, his note focuses on the fact that first-quarter GDP fell due to inventories, while consumer spending remained resilient, which could boost PCE.
“This has created a narrative of ‘stagflation’ or negative supply shock. We believe this view is flawed, as it is based on an apples-to-oranges comparison,” the company said.
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