Down Angle Symbol A symbol in the form of an angle pointing downwards. Jonathan Kitchen/Getty Images
- Slower growth and rising inflation have revived distant calls of impending stagflation.
- This would cause interest rates to remain higher for longer, putting pressure on U.S. businesses and consumers.
- One investor says anyone looking to hedge this risk should focus on fixed income.
Two economic reports have brought back a word no central banker ever wants to hear: stagflation.
The difficult scenario occurs when inflation rises and growth stalls – a dangerous combination that the US economy has just experienced.
Concerns arose as first-quarter GDP fell against expectations on Thursday, growing at an annual rate of 1.6%. This is a significant slowdown compared to previous quarters and well below estimates of 2.5%.
Just a day later, private consumer spending did the opposite and exceeded Friday's forecasts. The Federal Reserve's favored inflation measure rose 2.8% versus a consensus of 2.7%.
“If you take [the] Given the inflation report coupled with yesterday's GDP report, I think investors really need to brace for the resurgence of the stagflation debate,” Jeffrey Roach, chief economist at LPL Financial, told Business Insider.
If this actually comes to fruition, it would not be a pleasant sight for the markets.
There are lessons to be learned from the 1970s, a decade often cited as a cautionary tale. During this era, a cycle of low growth and double-digit inflation only ended when the Fed raised interest rates and pushed the U.S. into recession. When the problems first emerged, the volatility caused the stock market to decline.
Of course, stagflation is not Roach's base case, as he and other analysts want to see more data points before making such a decision.
“It really all depends on the inflation part of the equation and whether that forces the Fed to stay higher for longer,” Mike Reynolds, vice president of investment strategy at Glenmede, told BI. He also noted that he has been paying more attention to stagflation risks recently.
“Some Fed officials are raving about possible further rate hikes – that's not the consensus – but the fact that they're talking about it now is kind of indicative of the situation we're in,” Reynolds said.
Among the most prominent Wall Street voices currently warning of stagflation is JPMorgan CEO Jamie Dimon, who often points to the 1970s as a reason why markets shouldn't get too comfortable with the current economy:
“I would point out to a lot of people that things looked pretty rosy in 1972 – they weren't rosy in 1973,” he recently told the Wall Street Journal, warning that there could be a slowdown in the next two years amid rising inflation .
In the event that monetary policy is forced to stay higher this year, both Roach and Reynolds agreed that the consequences could come as early as 2025.
In Reynold's view, any fallout would be delayed by election-related fiscal stimulus, although this would only increase inflation and worsen the Fed's options.
Meanwhile, in 2025 and 2026, both the government and companies will carry over their debt, Roach said, adding that the risk of something breaking only increases if interest rates remain high.
To hedge against rising risks, Reynolds suggested a slight underweight in stocks. He said this could be offset by additional exposure to fixed income. However, investors should not focus too much on duration as future inflation risk could cause interest rates to rise and weigh on long-term assets.
Alternative investments could counteract any disappointment in bonds or stocks, Roach said.
But for now, stagflation is only a remote possibility and the threat could diminish with future reports or a GDP revision, both experts noted.
On Friday, Bank of America rejected the scenario, saying there were no signs of stagflation. Echoing Reynolds' arguments, the report focused on the fact that GDP fell in the first quarter due to inventory levels, while consumer spending remained robust – potentially boosting PCE.
“This created the narrative of 'stagflation' or a negative supply shock. We believe this view is incorrect as it is based on an apples and oranges comparison,” the company said.
Comments are closed.