Concerns about stagflation are growing in the US. It is every central banker’s worst nightmare

Concerns about stagflation are growing in the US. It is every central banker’s worst nightmare

Over the past few years, the US economy has grown at a rate that seems too good to be true.

So, at first glance, Thursday’s gross domestic product report showing the US economy grew at an annual rate of 1.6% in the first quarter of this year compared to a 3.4% rate in the fourth quarter of last year seems to be just the Federal drug. A reserve doctor was ordered. But there is only one problem: inflation.

The latest Consumer Price Index data showed inflation rising, moving further than the Fed’s 2% target. And economists predict new inflation data due on Friday will paint a similar picture. The GDP report provides another preview of what could happen.

Included in the report is an update on inflation from the previous quarter, as measured by the Fed’s preferred gauge, the Personal Consumption Expenditure price index. The latest data shows prices rose to an annualized rate of 3.4% in the first quarter compared to 1.8% in the last quarter of 2023.

Slow economic growth combined with rising inflation is known as stagflation. It is one of the ugliest terms for a central bank.

To be fair, a single GDP report does not necessarily indicate a trend. Also, Thursday’s data is subject to two subsequent revisions, which may indicate the economy is not slowing down or at all. But even if the data is unchanged, the US is faring better than the UK and Germany, where high inflation is coupled with almost non-existent GDP growth.

Still, the latest US GDP report is not a good sign for the Fed – or investors, as evidenced by Thursday’s sell-off in the US stock market.

Danger ahead?
A low unemployment rate tends to offset some of the pain brought on by high levels of inflation. This is because businesses can generally only raise prices when people have enough income to buy them. Conversely, when unemployment is high and people are stuck, businesses will have a hard time passing on higher prices to their customers, which keeps inflation low.

One of the worst bouts of stagflation occurred in the 1970s after rising oil prices from the Arab oil embargo on the US and other countries that supported Israel in the 1973 Yom Kippur War dramatically increased the cost of living. But when the Fed tried to ease inflation by raising interest rates, the economy fell into recession.

JPMorgan Chase CEO Jamie Dimon has concerns that history could repeat itself. The US economy “looks more like the 1970s than we’ve seen before,” he said earlier this week at a discussion hosted by the Economic Club of New York. He reiterated that message in a Wall Street Journal interview published Thursday before the GDP report was released. “Things were looking very bright in 1972 — they weren’t so bright in 1973,” Dimon said.

There are certainly eerie parallels to the 1970s, with heightened geopolitical tensions in the Middle East and rising oil prices, but many economists feel the US is nowhere near the situation it faced then. Even at its recent peak, inflation was well below the decade high of nearly 12%. At current rates, prices are rising more slowly than in the 1970s.

But the growing consensus among economists and investment strategists is that the days of Goldilocks economics, where inflation falls without slowing GDP, are numbered.

“While the Goldilocks narrative has been successful so far this year, in more ways than one it seems like she tripped over today’s GDP report and scraped her knees,” Mike Reynolds, vice president of investment strategy at Glenmede, wrote in a note Thursday.