The expanding global trade war threatens to infect the U.S. economy with a bout of “stagflation,” according to Loomis Sayles vice chairman Dan Fuss. In fact, the stream of tariff announcements, now affecting $800 billion worth of global goods, has prompted the storied fixed-income manager to dial down his outlook for economic growth around the world over the next two years. Four months ago, Fuss was upbeat and optimistic.
For most Americans, stagflation is a distant memory, one that caused inflation to accelerate and growth to slow half a century ago. It first surfaced in the late 1960s, initially in a mild way. But it eventually wreaked havoc on the U.S. economy characterized by three-hour gasoline lines in the late 1970s. Ultimately, inflation became so pervasive that Federal Reserve Board Chairman Paul Volcker felt compelled to raise interest rates so aggressively in 1981 that he triggered a nasty recession with double-digit unemployment.
If there is any good news, it’s that any incipient stagflation is likely to look more akin to the late 1960s than the corrosive 1970s variety, Fuss believes. He also doesn’t see an outright recession on the horizon. However, he doesn’t rule out the possibility of a “growth” recession that occurs when the economy slows, the unemployment rate rises and real sales growth deteriorates but nominal GDP growth remains marginally in positive territory.
Other observers like Jim Paulsen of The Leuthold Group also see the prospect of stagflation on the rise. Only a few like David Rosenberg of Gluskin Sheff are predicting an outright U.S. recession in the next 12 months.
Whatever happens, central bankers are taking notice. “Regional Fed governors are saying maybe our economic forecasts were all wet” with new trade restrictions emerging, Fuss says. What concerns him is that the Fed models only look at the first- and second-order effects of tariffs, not the third- and fourth-order side effects as they ripple through the interconnected global supply chain.
Furthermore, both of the Fed’s mandates -- fighting inflation and promoting unemployment -- address domestic economic issues, Fuss notes. That leaves it with a limited arsenal to fight the side effects of a trade war.
All this comes at a time when many were hoping the U.S. economy was emerging from a decade of secular stagnation. Four months ago, Fuss thought the economy would continue growing at a brisk clip into 2020, taking the 10-year Treasury to the 4 percent area. But he qualified that prediction with the caveat that it assumed there would be no major geopolitical shocks.
Now he’s thinking that the “geopolitical situation is far worse” than [it was] four months ago, as is the domestic political environment. “I’m guessing the Fed won’t be as aggressive,” he says. “The bottom line is a much slower economy.”
The impact on Main Street has just begun. While the U.S. economy has seen some great jobs reports in recent months, some employers may get nervous about uncertainty as successive rounds of tariffs rolled out.
Companies like GM and Harley Davidson are warning about layoffs or planning to shift production abroad. Mid-Continent Nail Corp., the nation’s largest nail manufacturer, says if it doesn’t receive an exemption from paying tariffs on steel from Mexico, it will face two choices: closing shop or moving its operations to Mexico.