It’s taken just a few short months for stagflation to go from hobgoblin of cranks to a full-blown Wall Street obsession.
Everyone seems worried about it. Bridgewater Associates co-Chief Investment Officer Greg Jensen says spiraling prices that choke off growth are a “real risk” that many portfolios are massively overexposed to. A “fairly strong consensus” of market professionals believe that some kind of stagflation is more likely than not, according to a Deutsche Bank AG survey. And while Goldman Sachs Group Inc. urged investors to buy the dip, strategists said “stagflation” was the most common topic in client conversations.
Wherever you fall on the debate, alarm bells are ringing as energy prices head toward multiyear highs and persistent shortages crimp supply chains worldwide. That’s fueling price pressures and pushing up bond yields just as economic growth is cooling and central banks such as the Federal Reserve weigh scaling down pandemic-era stimulus. And after a second straight month of disappointing U.S. jobs gains, the stakes are rising heading into this week’s inflation report.
“The reality that inflation is more persistent and sustainable than the ‘transitory’ camp thought, and that inflation and its causes are in turn slowing economy growth,” said Peter Boockvar, chief investment officer for Bleakley Advisory Group.
Energy Epicenter
Much of the stress is emanating from the energy market, where West Texas Intermediate crude oil broke above $82 per barrel for the first time since 2014 on Monday amid a power crisis from Europe to Asia. Prices of coal and natural gas have also jumped, with demand ahead of winter whittling worldwide stockpiles.
The commodity surge has thrust stagflation fears front-and-center in markets, given that higher energy prices have the potential to pinch consumers, according to Principal Global Investors. Gains in consumer spending are already expected to slow, leading Goldman economists to slash U.S. growth estimates over the weekend.
“The idea was already starting to take shape. The increase in commodity prices has just formalized those fears,” said Seema Shah, Principal’s chief global strategist. “While there have been complaints around higher food prices, higher lumber prices, higher clothes prices, it’s the increase in household bills that has really put fear into peoples’ minds, because it is so visible and rising gas prices are difficult to substitute away from for an average household.”
Murky Bond Picture
Sky-high commodity prices have filtered through to the Treasury market, where yields on benchmark 10-year notes broke above 1.6% for the first time since June last week. Driving the gain is an increase in breakeven inflation rates, while so-called real yields -- often viewed as a proxy of growth expectations -- have retreated so far this month.
“If we look at the composition within the TIPs market, we see an increase in breakevens to the detriment of real yields,” BMO strategist Ian Lyngen said on the firm’s “Macro Horizons” podcast. “We read this as the market’s focus on longer-term inflation has taken some of the optimism out of the growth profile going forward.”
Morgan Stanley strategist Andrew Sheets disagrees. Breakeven rates are still below their May peaks, while the cross-asset landscape is distinct from the stagflationary setup of the 1970s, he argued. Data compiled by Bloomberg shows gross domestic product is forecast by economists to rise 5.9% this year, 4.1% next year and 2.4% in 2023.