Blog: The Road to Stagflation
Stagflation is a stop along the road from growth to recession. But it's still a nasty place, and it's now a strong possibility.
Last week, while I was on that family vacation, two important bits of information came out:
1) Continued elevated “core” PCE inflation, and
2) Continued negative Global PMI growth from MARKIT
OK. PCE was released on March 31st, but I haven’t really been able to say much about it yet, except to say briefly it wasn't encouraging.
Since manufacturing often leads the overall macro economy, stagflation is beginning to look like a strong possibility. Stagflation, when it occurs, is a stop along the road from growth to recession. But it's still a nasty place. I wrote a paper at First Quadrant about the growth/inflation cycle available here. When we published the paper in June 2020 I thought stagflation was likely the next phase. While I correctly saw a rise in inflation, I did not take into account the massive monetary and fiscal stimulus programs at the time. So I incorrectly thought we’d continue to have negative growth. Now inflation remains elevated while growth is faltering, the conditions for stagflation.
In the paper I also showed the impact of the growth/inflation cycle on different asset classes historically, from 1975-2019. The short answer is everything does badly except gold. TIPS aren’t too bad but their return is still negative. CPI inflation over the stagflation periods averaged 6.8%. That’s a little higher than now, but not by much.
If stagflation does return, we would have high unemployment and continued high inflation. So what will the Fed and other central banks do? It depends on whether they cling tightly to their 2% target or not.