The Daily Update: Stagflation Not A Top Scenario

We’ve had Japanification worries, hyperinflation worries, and now some observers are talking about another worry, stagflation.

Stagflation is a mixture of weak growth, even recession, along with rising prices, which is possibly the most dangerous scenario of them all. It could be said that stagflation is the one that keeps central bankers awake at night. The headache that stagflation gives policy makers is that they have only limited room to manoeuvre monetary policy, needing to raise rates due to higher prices, but at the same time requiring lower rates to support growth.

Since the world has started to re-open, after the global pandemic, we know and have written about the possibility of a “K” shaped recovery. Households that were unable to spend during lockdown, emerged with plenty of available spending power. However, on the lower part of the “K” you have those who have not participated or benefited from the various lockdowns, basically just scraping through the recent problems and so have not added to the economic pickup.

The recent spike higher in prices along with growth, the so-called “reflation trade”, which has driven stock markets, especially those on both sides of the pond to near all-time highs appears to have stalled in terms of much higher economic activity but not in terms of inflationary pricing. This has some thinking stagflation could take hold. This has been encouraged by recent employment data, both last month’s ADP and Non-Farm payroll numbers came in weaker than the calls, while wage growth continues to move higher.

We remain of the view that the recent rise in prices and wage growth is transient, caused by furlough schemes and supply side bottlenecks, as these short-term issues get worked out, which may take several months, the pricing pressure will dissipate. Growth has come off the highs seen after the various economies reopened, but that was to be expected, some further weakness will be seen as certain areas get a spike in infections reducing the work force and closing businesses. However, growth is not that weak, PMI data etc still remain expansionary, just not as strong as immediately after the reopening.

We do expect inflation to linger as it often can be very sticky, but as more and more return to normal, although there may be a new normal, the price pressures will return closer to central bank targets.

Broadly, is stagflation around the corner?? That's a scenario outside our top ten most likely.

Have a great day and stay dry.