Transitory has become the biggest buzzword in finance over the past year, but a new candidate for that honor is now nipping at its heels: stagflation. Both terms come with a fair degree of interpretational subjectivity and both reflect important macroeconomic dynamics with significant investment implications. It matters greatly whether the current inflation spike fades away and whether the world economy is about to enter a prolonged stagflation period. Is the latter truly a risk?
In some places, one could argue that we are already in that phase. All the same, we believe the risks of genuine stagflation over an extended period (two quarters or more) remain low — not because inflation is about to dissipate, but because growth seems poised to reaccelerate as we enter 2022. The good news then is that if stagflation were to be confirmed at some point (in retrospect with data in hand), we would already be a good way ahead of it. Perhaps a new term to consider in this context then is transitory stagflation!
But before we get ahead of ourselves, let us first define the term stagflation, because the definition can greatly influence the conclusion. We adopt a fairly stringent definition of stagflation: little to no growth accompanied by above-average inflation.
Viewed in those terms, the inflation side of the equation is clear. Consumer price inflation sits at 5.4% year on year in the United States (US), 4.1% in Germany, 3.4% in the eurozone and 3.1% in the United Kingdom. All of these numbers are well above the recent-year averages and would remain so even if they were to meaningfully decelerate over the next six months. This means that the growth side of the equation must settle the question.
We look at the US and Germany as case studies in the stagflation debate. After a very strong start to the year and a robust second quarter, estimates for third-quarter US real GDP growth have collapsed precipitously in recent weeks, now below a seasonally adjusted annual rate (SAAR) of 1.0%. If the actual GDP data comes in weak as well, the stagflation test could arguably be met (Figure 1).
Figure 1: Stagflation Signals From the US?
Germany is another interesting example. Consumer price inflation has hit a three-decade high, while growth momentum has languished (Figure 2). The hoped-for second-half reacceleration has given way to a string of disappointing data releases, both for industry and consumer spending. To top it all off, supply chain constraints appear to have hit the industrial sector especially hard.
Figure 2: Stagflation Signals From Germany, Too?
Except for the early days of the pandemic, production of motor vehicles, trailers and semi-trailers has not been this low since the height of the Great Recession and, prior to that, since the late 1990s. Of course, motor vehicle production is not the whole of German manufacturing, nor is manufacturing the whole of the German economy. Nonetheless, a stagflation call in Germany’s case could seem justified.
Stagflation Dynamics a Temporary Problem
If one were to look carefully, instances of stagflation-type dynamics could be identified across the global economy. But we believe that these instances will be temporary – to borrow the word of the moment, we think they will be transitory. These flashes of stagflation seem to be rooted in supply chain problems, and the growth slowdown seems likely to be very brief (for a quarter or two). Whether it takes another four, six, or even eight months for supply chains to materially normalize, it seems highly likely that backlogs and delivery times will improve in the coming months. At that point, deferred activity should resume, and overall growth should reaccelerate.
US motor vehicle sales can serve as an example: we got two recession-type readings for this indicator in August and September. During those two months, sales averaged 12.6 million annualized, compared with a peak of 18.5 million in April and an average of 16.8 million during the first half of 2021. Surely this is not an instance of disappearing demand but rather of delayed consumption. When the supply chain situation improves, the demand pipeline will be there, which should jumpstart a pick-up in activity.
Inflation could still be quite high at that point — in fact, supply chain normalization may bring shorter lead times before it brings lower prices — but such a growth reacceleration would kill the stagflation argument. Just as prospects for a Goldilocks economy have disappeared over the past few months, we believe that speculation about stagflation will also be put to rest over the next few months.
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