Are We In Stagflation?

Depending on which economist, strategist, equity or fixed income portfolio manager you follow, the view that we are now in stagflation varies. But that difference in opinion is not the interesting thing. What is more interesting is the variation in the underlying models and analysis they point to, in order to draw their conclusions. The lack of consensus is notable.

What is obscured is causality.

There is the orthodox view that inflation is a result of supply and demand imbalances: With monetary and fiscal leniency granted to support economies through COVID, driving demand; And supply chain blockages suppressing the just-in-time delivery of goods, the inflationary logic follows. From a demand perspective, hiking rates to stem demand is the classic monetarist doctrine. And that is what is happening in the US, UK and soon in Europe (but interestingly, not in Japan!!!).

The result: asset prices and disposable income decline as rates rise, creating a negative wealth effect. And a higher cost of capital that reduces investment. i.e. monetary induced demand control to remove inflationary pressures.

But what if the driver of inflation is more skewed towards supply and not demand. i.e. variables which are beyond the control of monetary policy. Specifically, a persistent zero-COVID policy in China disrupting manufacturing and shipping. And the duration of the Russia-Ukraine crisis prolonging heightened food prices and energy costs that impact households and the final price of manufactured goods.

The result: Hawkish monetary policy will have limited impact on supply driven inflation, and primarily impact growth negatively.

Whilst consensus GDP forecasts point to low single digit growth for Full Year 2022/3, inflation today is still at high single digits. And Jackson Hole is just around the corner. These statistics and fears may explain the high volumes of investor traffic in our PRO site researching "which assets do well in stagflation".