Stagflation: Prepare for It!
Since I raised the possibility of stagflation in a note last October, and revisited the theme a couple of weeks ago, the surge in energy prices in the wake of the Russian invasion of Ukraine has increased the likelihood of a recession combined with rapid price increases.
Federal Reserve Chairman Jerome Powell has pretty much assured investors that the central bank will increase the Federal Funds rate by a quarter point next Wednesday at the end of a two-day meeting of the Federal Open Markets Committee. Why, on the other hand, will the voting members not decide to postpone the move considering this month’s deterioration in the supply chain relating to energy, metals and food, and implications for slower growth?
That is because we learned Thursday that consumer prices rose by 7.9% in February compared with a year ago, the fastest pace since January 1982. The elevated inflation rate, the presence of large price increases in a wide variety of goods and services, and the likelihood that the inflation rate for March and April will be even higher, mean that Powell and his colleagues will be forced to disregard the recessive nature of a monetary tightening at a time of rising energy cost.
A quarter point rise in the Fed’s interest rate will do little to quell inflationary pressures. Expect Powell to follow up at his press conference next Wednesday with promises (threats?) to increase rates several more times this year, as well as to start reducing the balance sheet from the current level of almost $9 trillion. Expect also for him to say that the Fed hopes to engineer a safe landing of the economy. Take such a statement not just with a pinch of salt but by giving it the same credibility as past Powell statements about inflation being “transitory.”
President Joe Biden suggested after the latest inflation figure was released that we blame Putin for it. While the Russian president can be blamed for the Ukraine invasion and for the tragic loss of human life, he was not responsible for the price increase last month. Calculations by the US Bureau of Labor Statistics were done before the invasion began. The February inflation rate resulted from supply bottlenecks, a massive fiscal stimulus that the economy has yet to absorb in full, and a more-than-doubling of the Federal Reserve’s balance sheet since covid began.
The Ukraine crisis, however, will be a major factor in the likely acceleration in inflation in coming months, and for making it even more longer lasting. Secretary of the Treasury Janet Yellen, who had said as recently as early February that she expects inflation to fall to 3% by the end of this year, said on CNBC Thursday that the war would result in even faster price increases. The war is “exacerbating inflation,” the Secretary admitted.
And the exacerbation is why senior Biden administration officials can no longer claim that supply bottlenecks stemming from covid will get resolved with time, or that no massive monetary and fiscal tightening is necessary. What Paul Volcker found on assuming the Chairmanship of the Federal Reserve in August 1979 was that the inflation genie cannot be easily put back into the bottle once it is out.
The US economy faces the highest inflation rates since that era four decades ago, with the similarity that excessive monetary expansion during the 1970s and in recent years was a major factor in the rapid price increases. Another parallel between the 1970s and now is that the rise in price of an essential input — oil during the 1970s, energy overall today — is a component in inflation’s acceleration. The indispensability of that input makes it unlikely that cheaper substitutes can be used to quell inflation.
What can investors do as they anticipate stagflation? There is no easy solution as there would be for a recession or inflation by itself. Commodities, normally a hedge against inflation, could be hurt by the accompanying demand destruction resulting from high prices. Safe havens during recessions — long-dated US Treasurys, German bunds — are likely to lose value because of rising yields due to accelerating inflation.
The essential, but not entirely satisfying, steps may be to add to holdings of cash reserves, and for investors to increase the time horizon of their investments.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
March 12, 2022
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Sri-Kumar Global Strategies, Inc. assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. Sri-Kumar Global Strategies, Inc., or its employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time without notice. ©Copyright 2022 -- Sri-Kumar Global Strategies, Inc., 312 Arizona Avenue, Santa Monica, California 90401; Telephone: +1-310-455-6071