Paul Volcker

October inflation slowed more than expected, but remains near 40-year highs. Here’s what 5 experts said about the risk of stagflation hitting the US economy

Paul Volcker, former Fed Chairman from 1979 to 1987.

  • Inflation eased in October, but prices have been high for more than 20 months now, raising fears of stagflation.
  • This means the economy could be hit by high unemployment, weak growth and persistent inflation – as well as a sharp drop in stocks.
  • Here’s what five experts said about the risks of stagflation and why markets should be more worried.

Inflation has slowed more than expected in October’s Consumer Price Index report – but prices are still well above the Fed’s 2% target, and they are above of the lens for 20 months now.

This “sticky” inflation has sparked fears of stagflation, a dreaded scenario where high inflation takes root in expectations, slamming the economy with a whirlwind of slow growth, high unemployment (and yes, high prices).

These conditions defined the US economy throughout the 1970s and early 1980s, causing the Fed to raise rates above 19% in the early 1980s. It was the tightest monetary policy ever. recorded, and it triggered a recession and a staggering stock market crash.

Fortunately, the evidence for another potential crisis is mixed, and the slowdown in inflation in October should help ease some fears. Five-year inflation expectations are still hovering around the 2% level, and experts have pointed out that inflation often lags official statistics, meaning prices could be overstated and even lower than that. as the latest CPI suggests. Hiring is still tight and unemployment remained in check at 3.7% in October, meaning the labor market held up amid the Fed’s scramble to rein in prices.

As investors digest mixed signals about the direction of the economy, here’s what five experts have said about the risk of stagflation gripping the US economy.

Deutsche Bank analyst Henry Allen

German Bank

Despite inflation cooling in recent months, markets are seriously underpricing the risks of a return to 1970s stagflation, Deutsche Bank analyst Henry Allen wrote in a recent note.

Allen pointed out that inflation has remained high for a significant part of this year, and although headline inflation was on a downward trend, “sticky” prices – prices for goods and services that do not change frequently – continued. to accelerate in the September inflation report, and barely cooled by 0.03% percentage points in October. Together, these indicators are “very bad news”, as they are great omens for inflation expectations to embed in the economy.

If inflation remains persistent, it would lead to an even higher interest rate from the Fed, Allen warned, which could spell trouble for equities: “If the experience of the 1970s is repeated, investors expect an extended period of negative real returns for both bonds and equities,” he said.

Mohamed El-Erian, Chief Economic Advisor of Allianz

Mohamed El-Erian
Mohamed El-Erian

Leading economist Mohamed El-Erian believes that the United States is already headed for a stagflationary crisis, as evidenced by low levels of growth and high levels of inflation this year.

“We are slowly sliding into stagflation,” El-Erian said in a recent interview with Bloomberg. “We could end up not doing enough on the inflation side and then end up in a recession for Europe, a near-recession for the United States and for China.”

El-Erian has sounded the alarm over rising inflation since 2021 and has become a vocal critic of the Fed’s policy response and the central bank’s insistence that rising prices were “transitional” ahead of an aggressive rate hike this year. That increases the likelihood of a slowdown – but the risks of stagflation mean the Fed cannot back down from its aggressive rate-hike regimen, he said, warning it would be another policy mistake to halt the Fed tightening at this point.

“I don’t think they can stop now. Because their credibility is so damaged that if they stopped now, people would immediately say, ‘This is the Federal Reserve of the 1970s. This is the Fed turning around, and we’re going to have prolonged stagflation,’” he warned in an interview with New York Magazine in October. “I will tell you that the consequences of this are worse than the consequences of the Fed lawsuit.”

“Dr. Doom” Nouriel Roubini, NYU Stern Professor of Economics

Roubini

Roubini, who has earned a reputation as Wall Street’s leading pessimist, has warned that high levels of inflation and high debt mean the United States could be hit by a stagflationary debt crisis – a crash at the Frankenstein that combines aspects of the stagflation of the 70s and the financial crisis of 2008.

That means low growth, high unemployment and a painful recession in the United States, he warned. In a recent interview with Fortune, he estimated that a mild recession could send the S&P 500 down another 10%, and a severe recession could send the index down 30% to the 2,700 level. Bonds, credit and other assets could also crash, causing more damage.

This market rout could also last for years, he warned, due to high levels of debt and ongoing supply problems around the world, which could delay any market recovery.

“We could be closer to a period like the one we had between 1973 and 1982, where stocks fell and were very, very low for a long time… We could have a long-term crash,” Roubini said, adding that its severity would be comparable. to what was seen in 2008.

Steve Hanke, professor of economics at Johns Hopkins University

Steve Hanke Johns Hopkins Finance Class

The Fed could easily drag the United States into a stagflationary crisis next year, Hanke said, given high inflation and strong prospects of an impending recession. In a recent Daily Caller op-ed, the top economist pointed to a contraction in the M2 money supply this year, which includes all cash deposits, checks and savings in circulation. It’s a major precipitator of a recession, he said, calling a downturn in 2023 “baked in the cake.”

“Thanks to the Fed’s monetary mismanagement, broad money (M2) in the US has contracted 1.1% over the past 7 months,” he tweeted in early November. “With this contraction, a recession is imminent. In 2023, we will see persistent inflation and a recession – STAGFLATION,” Hanke warned.

Michael Hartnett, Chief Global Equity Strategist at Bank of America

Bank of America
A sign hangs above a Bank of America branch in the Financial District November 1, 2011 in Chicago, Illinois. Bank of America Corp. reportedly announced that it would drop plans to charge customers a $5 per month fee to make purchases with their debit cards.

The United States has already been hit by stagflation this year, Hartnett’s team of strategists said in a note earlier this month.

“Inflation and stagflation were not expected in 2022…hence the $35 trillion collapse in asset valuations,” the note said. In a separate note, Bank of America warned investors to prepare for the scenario that the next recession would be stagflationary, given that it takes about a decade on average for a developed country to bring inflation down to 2%, a when prices exceed 5%. threshold.

But that doesn’t necessarily mean prolonged losses for the stock market, Hartnett’s team said. Relative returns in 2022 closely track what was seen from 1973 to 1974, the years when the inflationary shock began to subside. In the 1970s, this prompted stocks to enter “one of the greatest bull markets of all time”, meaning that a rally could soon set in and trigger a market rally.

Read the original article on Business Insider

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