With Halloween right around the corner, children across the country will be looking to avoid the many monsters and ghosts that await them at each house in their neighborhood as they hurriedly fill their bags with candy. I’ll be donning a Man in the Yellow Hat costume as my son recently took to the Curious George books. He’ll be dressed up as Curious George, which is quite fitting for a six-year-old who continues to explore the world with curiosity, both mischievously and otherwise.
One question I find myself considering this Halloween is, “If the economy were to dress up for Halloween, what would it dress up as?”. Admittedly, it’s a ridiculous question, but there’s been a resurgence of “spooky” topics that have grabbed the attention of investors more so in the past few months than they have since the beginning of the pandemic.
Would the economy trick or treat as a smoldering budget bill signifying the infighting and lack of cohesion in Washington D.C.? Or maybe the economy would dress up as a stranded shipping container highlighting the dysfunctional supply chain. Or better yet, it could wear a pair of diamond-encrusted sunglasses with the lenses shaped like dollar signs and carry around a barrel of crude oil, signifying the global energy shortage!
These would all make for some terrifying costumes (and they are all indeed risks the market is facing these days), but there’s one “costume” the market seems to be discussing the most and yet carries the most ambiguous risk of the bunch: Stagflation.
First, let’s define stagflation as this economic headwind has not been faced since the 1970s. Stagflation has two components. The first is a stagnant economy where GDP growth is stifled or receding. The second is a period of persistent, above-average inflation. When an economy has low or negative growth combined with high inflation, you get stagflation.
At the risk of stating the obvious, economies want to avoid stagflation because it means goods and services are getting more expensive. At the same time, consumers have fewer dollars to spend due to high unemployment and an unstable economy. When stagflation first appeared in the 1970s, it was primarily a result of high energy prices driving inflationary trends and causing unemployment to increase due to the higher cost of goods. But is that what’s happening in 2021?
Let’s tackle inflation first, as the term “transitory” has become the word everyone loves to hate. Yes, we’re indeed seeing inflation persist longer than we originally anticipated at the beginning of the year when we thought the economy would reopen and everything would return to normal. That’s obviously not the case today. The New York Federal Reserve inflation survey recently showed the median one-year ahead expected inflation to be at 5.3% while the three-year ahead expectation is at 4.2%. Both are historically high rates since the survey began in 2013.
It’s clear that inflation is unlikely to be transitory at this point, especially as energy prices continue to increase worldwide. Add a supply chain bottleneck and increased labor demand driving wages higher, and we can see how the stage is set for higher prices for longer. With that said, we still don’t expect inflation to run away from us as the Fed is already setting expectations for a rate hike at the end of 2022, which would directly combat the effects of inflation. Companies and consumers will need to adjust to higher prices (or fewer services) over the next year or two as the economy continues to normalize. Still, run-away inflation remains a relatively minor risk.
So what about economic growth? In order to have a stagflated economy, you need to have growth expectations go to zero or turn negative. Well, that’s not the case today. Currently, expectations for GDP growth average 6.1% for 2021 and 4.4% for 2022, before flattening out to 2-2.5% for 2023 and beyond. Yes, that does mean growth is slowing, but it’s not negative. And keep in mind GDP contracted -3.5% in 2020 due to COVID. Before 2020, GDP was averaging between 2-3% depending on the year.
There are certainly concerns the U.S. economy may hit a period of stagnation as the consumer comes off of the sugar high of pandemic-related fiscal stimulus over the coming years. However, even with fiscal and monetary policy normalizing, the average consumer is in a relatively healthy position, especially given the current unemployment environment. Job openings remain elevated at historic highs above 10 million jobs for the last two months, and quit rates continue to creep higher, suggesting workers are able to find more attractive jobs relative to their current roles. If stagflation were to occur, job openings and quit rates would both need to be significantly lower.
Does this mean we can all stop worrying about stagflation dressed up as the economic boogie man hiding in the closet? Never say never, but at this moment in time, it would appear we only need to concern ourselves with the “flation” half of stagflation. It’s looking increasingly likely the economy is going to need to digest more than a bite sized serving of inflation over the coming quarters. As long as it doesn’t turn itself into a king-sized portion, the consumer and corporate America should be able to stomach modestly higher inflation without experiencing too much of a stomachache.
I promise I’m done with the candy puns now…