- Slowing growth and rising inflation have revived distant cries that stagflation is on the horizon.
- That would force interest rates to remain high for an extended period of time, putting pressure on American businesses and consumers.
- One investor says those looking to hedge this risk should look to bonds.
The two economic reports brought to mind a word no central banker wants to hear: stagflation.
This difficult scenario occurs when inflation rises and growth stalls, a dangerous combination that the U.S. economy has just experienced.
Concerns arose after Thursday’s first-quarter GDP data showed unexpectedly weaker-than-expected growth, at an annualized rate of 1.6%. This is a significant slowdown from the previous quarter and well below expectations of 2.5%.
Just one day later, consumer spending on Friday actually exceeded expectations. The Fed-backed inflation measure rose 2.8%, compared with a consensus of 2.7%.
“If I take it [the] We’re going to release an inflation report in conjunction with yesterday’s GDP report, but I think it’s the return of the stagflation debate that investors really have to start taking a stand on,” said LPL Financial Chief Economist. , Jeffrey Roach told Business Insider.
If this actually takes hold, it will not be a welcome situation for the market.
Lessons can be drawn from the 1970s, which is often cited as a cautionary tale. During that era, the cycle of low growth and double-digit inflation ended only after the Fed pushed interest rates so high that it pushed the United States into recession. When the issue first emerged, volatility caused the stock market to fall.
To be sure, stagflation is not Roach’s base case, and he and other analysts would want to see more data points before making such a judgment.
“It all depends on the inflation part of the equation, and whether that forces the Fed’s hand to go up for an extended period of time,” Mike Reynolds, vice president of investment strategy at Glenmede, told BI. He also said that he has recently started paying more attention to the risk of stagflation.
“Several Fed officials have floated the idea of the possibility of further rate hikes, and while it’s not a consensus, the fact that it’s being talked about now kind of makes us think “It shows the situation we’re in.”
One of the most prominent voices currently warning of stagflation on Wall Street is JPMorgan CEO Jamie Dimon, who says the market should not get too comfortable with the current economy. He frequently cites the 1970s as the reason.
“I point out to a lot of people, things looked pretty rosy in 1972, but they weren’t as rosy in 1973,” he recently told the Wall Street Journal, adding that rising inflation was He warned that an economic slowdown could occur over the next two years.
If monetary policy is forced to remain high this year, both Roach and Reynolds agreed that the effects could be felt as early as 2025.
In Mr. Reynold’s view, election-related spending would have a delayed effect, but this would only accelerate inflation and worsen the Fed’s options.
Meanwhile, in 2025 and 2026, both governments and businesses will reschedule debt, Roach said, adding that if interest rates remain high, the risk of something failing will only increase.
Reynolds suggested a modest underweight in stocks to avoid increased risk. He said this could be offset by adding exposure to fixed income, but investors may want to focus on duration as future inflation risks could push interest rate upside higher and weigh on long-term assets. He said that one should not be overly exposed to.
Roach said alternative investments could offset the disappointment in bonds and stocks.
But for now, both experts said, stagflation remains a distant possibility, and future reports and GDP revisions could reduce the threat.
Bank of America pushed back against that scenario on Friday, saying it saw no signs of stagflation. Echoing Reynolds’ points, the note highlighted the fact that while GDP in the first quarter was reduced by inventories, consumer spending remains resilient and could boost PCE.
“This has given rise to a narrative of ‘stagflation,’ or a negative supply shock. We believe this view is misguided, as it is based on comparing apples to oranges.” said.