Is the Threat of Stagflation Returning in the USA?

The Fear of Stagflation in the Financial Markets

While most economists dismiss the possibility of a new wave of stagflation, other prominent figures in the financial landscape are starting to show some concerns.
The U.S.
economy is showing signs of slowing growth with persistent inflation, a combination that, if not properly managed, could lead to significant challenges for financial markets and the economy as a whole.
The worries expressed by influential figures like Jamie Dimon and the analyses of institutions like BoFA are alarming, and many are wondering what to expect next.

What is Stagflation and Why is it Dangerous

Stagflation poses a major question mark for monetary and fiscal authorities as it often has been a consequence of strategies used to counter inflationary problems.
During periods of high inflation, central banks typically raise interest rates to reduce aggregate demand and curb inflation.
However, this increase in interest rates tends to slow down the economy and can lead to higher unemployment.
Likewise, measures to stimulate economic growth, such as tax cuts or increases in public spending, can increase aggregate demand and, consequently, inflation.
Therefore, often in a period of stagflation, central banks are literally tied up and find it particularly challenging to manage the country’s economic condition.

What Happened in the Past During Stagflation Periods

A relevant historical example of stagflation is the United States in the 1970s.
During this period, the oil shocks of 1973 and 1979 led to a sharp increase in energy prices, which resulted in high inflation.
The situation was exacerbated by expansive monetary policies in the early 1970s, which further fueled inflation.
The economy entered a phase of low growth and high unemployment, and the stock market suffered heavily.
The S&P 500 index, after reaching a peak in 1973, dropped, and it took several years before the markets fully recovered.

Why There is Still Fear of a New Stagflation

Although many economists consider a new wave of stagflation unlikely, some recent signs are concerning analysts and markets.
The Consumer Price Index (CPI) in the United States has remained stable in recent months, suggesting a possible persistence of inflation.
Additionally, the U.S.
Department of Commerce recently announced a real GDP growth of 1.6% annualized for the first quarter of 2024, a sharp decline from the 3.4% in the fourth quarter of 2023.

Jamie Dimon, CEO of JPMorgan Chase, has expressed concerns about current economic risks.
During a recent event, Dimon stated, “I’m worried it looks more like the ’70s than we’ve seen before.” This reference to the 1970s underscores the fear of a return to stagflation, a period that brought significant economic hardships and market instability.

Bank of America (BoFA) has also expressed similar concerns in a recent note, stating that the U.S.
economy could transition from a “goldilocks” scenario (moderate and stable growth) to stagflation, with real GDP growth below 2% combined with CPI inflation in the 3-4% range.

How the Stock Market Could React to Stagflation

Historically, stagflation periods have had a negative impact on stock markets.
During the 1970s, the S&P 500 experienced significant losses.
Companies struggled to maintain profit margins due to rising commodity costs and weak demand.
Investors, concerned about economic uncertainty, tended to sell stocks, leading to price declines.

Today, the S&P 500 faces a complex economic landscape.
Markets are pricing in a scenario markedly different from stagflation; speaking in technical terms, they seem certain of a successful soft landing orchestrated by the Federal Reserve.
Not surprisingly, the S&P 500 continues to reach new highs daily, despite many indicators signaling an overbought zone’s arrival; for example, the RSI oscillator at 14 periods on a daily and weekly timeframe has exceeded 70 points.

Could a 1970s-style Stagflation Return?

Many are now wondering if it makes sense to expect the return of a terrifying period of global stagflation, or at least in the world’s main economy, the United States.
There is no definitive answer to this question, but there are two major truths to consider:

The first is that objectively, the U.S.
economic state in 2024 presents clear differences from the 1970s.
Among the key elements to consider is the fact that, among the ingredients of stagflation, one of the main ones seems to be missing at the moment: unemployment.
Currently, the U.S.
unemployment rate is 4.1%, and although rising, it is half of what it was in the 1970s, which was around 9-10%.

The second major truth, on the other hand, is negative, in the sense that it exposes the market to new possible unjustified fears.
This means that to cause a stock market crash, there might not be a need for heavy stagflation like that of the 1970s.
Markets are taking the soft landing for granted to the extent that the arrival of clues that could suggest a worse economic context could indeed be enough to generate panic.