The combination of sticky inflation and slowing growth is giving rise to a nightmare scenario of stagflation
Is the Fed at risk of finding itself in a nightmare stagflation scenario?
Photographer: Graeme Sloan/BloombergLisa Abramowicz
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Worst of All Worlds
Four months into 2023 and we've already cycled through no-landing, hard-landing and soft-landing scenarios. But something potentially even more insidious keeps creeping up: What happens if inflation remains higher than in the past and growth keeps slowing? Or, to put it another way, we just get a period of stagflation.
"Stagflation is the worst case scenario," said Seema Shah of Principal Asset Management. It's not an impossible outcome by any means, especially with the employment cost index coming in higher than expected. While higher wages will support consumer spending and growth more broadly, it's clear that growth is slowing down, in some cases materially.
As Jon noted, there's a growing belief that the economy will lose momentum in the second quarter, and Tom kept going back to the classic "sell in May and go away" mantra which has some historic basis.
"We're expecting negative GDP prints in the third and fourth quarter of this year," said Phil Orlando of Federated Hermes.
This is opening up the door to a softening in the stance of central bankers who until now have been dead-set on killing inflation. Tides are shifting heading into next week's Fed and ECB meetings. And Kamakshya Trivedi of Goldman Sachs doesn't see a different playbook among the global central banks. "Central banks want to pause or want to step down the pace of tightening they have been delivering," said Trivedi.
60-40 At Risk
If inflation stays high, it'll create a challenging environment, especially for those relying on the classic 60/40 portfolio model of investing.
“I’ve looked at this going back 150 years and when the inflation rate trends is sustained above the historical average, which is 3%, then the 60/40 doesn’t work,” says Jurrien Timmer of Fidelity Investments.
Timmer explains that on a 10-year rate-of-change basis, inflation was at about 2%, now it’s about 2.5%. “It really comes down to whether the inflation situation remains structural or transitory.”
A Few Laughs
The annual White House Correspondents’ Association dinner will be taking place Saturday in Washington. It’s an annual highlight for journalists and politicians from both parties to relax and (hopefully) share a few laughs. The highlight, of course, will be a bit of schtick from the President. Our Washington Correspondent Annmarie Hordern, who will be at the Hilton for the event, notes the context of President Biden’s appearance has changed, now that he’s a candidate for re-election. Even in the context of a little levity, he’s on display for 2024.
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