Why fears of a return to stagflation amid weak recovery are overblown
- Inflation rates are exceptionally low compared with the late 1970s and early 1980s, and there is little evidence of a rapid broadening of price pressures
- What really concerns investors is how policymakers, in particular the Fed, plan to support flagging growth while maintaining financial stability
What a difference six months make. In March, respondents to Bank of America’s fund manager survey were overwhelmingly bullish. A net 91 per cent of investors expected stronger global growth, the most optimistic outlook since the survey began in 1994.
An extreme example of the damage wrought by the virus is Australia. Renewed lockdowns to counter a surge in infections are driving the economy to the brink of a double-dip recession just as headline inflation hits its highest level since 2008. The predicament poses a dilemma for Australia’s central bank, which is slowing the pace of its asset purchases without knowing how quickly the economy will recover.
The unsettling combination of a faltering recovery and stubborn price pressures is present in other major economies to varying degrees.
Even in the euro zone, where manufacturing and services sector activity continues to expand briskly, growth is slowing. This is especially so in export-oriented Germany, where supply chain disruptions have hit the country’s car industry particularly hard.
As commodity prices surge and pressure builds on manufacturers to raise prices to help offset the surge in input costs, some investors worry that supply constraints will persist for longer than central banks anticipate.
These fears are overdone for several reasons. First, the word stagflation is being used loosely. Not only are current rates of inflation exceptionally low compared with those in the late 1970s and early 1980s, there is little evidence of the rapid broadening of price pressures – particularly in labour markets – that would indicate inflation is getting out of control.
Still, just because the global economy is not heading for 1970s-style stagflation, it does not mean the stagflation narrative has run out of steam. Markets tend to overreact and are sensitive to shifts in the economy.
The reality is that growth continues to slow while inflationary pressures remain strong. What really concerns investors is how policymakers, in particular the Fed, plan to support flagging growth while maintaining financial stability.
In Bank of America’s latest fund manager survey, the two biggest threats facing markets were inflation and a repeat of the 2013 “taper tantrum”. The former stems from the risk of policy being too loose, the latter from it being too tight. The Fed has its work cut out.
Nicholas Spiro is a partner at Lauressa Advisory