For the U.S. economy, it is more terrible than inflation, perhaps the era of stagflation is coming again.
The two major economic data released by the United States yesterday are the GDP for the first quarter and the core price index for the first quarter.
According to the data, the year-on-year growth of gross domestic product (GDP) in the United States unexpectedly fell to 1.6% in the first quarter, down more than 50% from 3.4% in the fourth quarter and the lowest level since the second quarter of 2022.
At a time when the GDP growth of the United States in the first quarter was "upset", core inflation was unexpectedly stubborn. The Fed's preferred inflation measure, the core PCE price index, rose more than expected 3.7% in the first quarter, the highest since the second quarter of 2023, higher than the expected 3.4%, and rebounded sharply from the 2% growth rate in the fourth quarter.
A series of data shows that while inflation remains high, economic growth is starting to slow or even stagnate, which means that there may be stagflation in the United States.
"Stagflation" is considered the worst nightmare facing the Fed and is more difficult to deal with than a recession.
Is U.S. Stagflation Really Coming?
JPMorgan Chase & Co. CEO Jamie Dimon noted earlier this week that while the U.S. economy remains strong, there could be a period of stagflation.
Dimon worries that the U.S. economy could repeat the mistakes of the '70s, "yes, I think it's possible that ['70s-style stagflation] to happen again." Now it looks like our situation is more like the 70s, and in 1972 the situation looked quite optimistic, but in 1973 the situation took a sharp turn for the worse. ”
Dimon has frequently warned for months that the U.S. economy faces a range of risks to resilience that, as he said in his April 8 letter to shareholders, could lead to "more stubborn inflation and higher interest rates than the market expects."
Dimon warned the market that inflation and interest rates in the United States may continue to be higher than market expectations due to excessive government spending, and is ready for the Federal Reserve to raise interest rates to a maximum of 8%.
However, there is also a view that the emergence of stagflation is still far away, and although inflation has not yet cooled, the market still expects at least one rate cut this year, while domestic demand in the United States remains strong.
Barclays analyst Pooja Sriram noted after the release of the GDP report that the increase in domestic sales showed that "demand conditions remain strong", with consumer spending rising by a solid 2.5% and business investment growth exceeding expectations, mainly dragged down by imports and inventories.
CICC Liu Gang's team believes that the seemingly weak GDP data does not indicate that the economy is weak, and the PCE, which exceeded expectations in the first quarter, is not a stagflationary combination.
A similar view was shared by CICC's Xiao Jiewen team, who pointed out that one factor dragging down GDP growth was the high growth of imports, and the other was weak inventory investment.
Despite this, a growing number of economists and strategists believe that confidence in the "Goldilocks" is being gradually shattered by the data, and Mike Reynolds, vice president of investment strategy at Glenmed, bluntly said that although the "Goldilocks" narrative has dominated the market economy narrative this year, in many ways, the "girl" seems to have tripped over the GDP report and grazed her knees.
Striking resemblance to the 70s of the last century
In the 70s of the last century, the United States was once mired in the quagmire of "great stagflation", the conflicts in Vietnam and the Middle East caused the United States to face problems such as energy crises, shipping disruptions and surge deficit spending, and the two oil crises in 1973 and 1979 led to a surge in energy prices, and high energy prices caused the inflation rate in the United States to soar, which once reached a high level of 13.5% in 1980, accompanied by high unemployment and sluggish economic growth.
Warnings of possible stagflation in the U.S. have been sporadic since 2021 and have been mentioned several times in 2022 and 2023, but the market believes that the U.S. economy is likely to remain strong and inflation may gradually subside. However, Thursday's data unexpectedly upended that idea, while also keeping the debate about the possible stagflation in the United States going.
Michael Hartnett, a global equity strategist at Bank of America, said that the U.S. economy is in a 70s-style dilemma, with sticky inflation but the economy is cooling down, and investors are turning a blind eye to it and will do so at their own risk.
Michele Schneider, chief strategist at Market Gauge, said in the report that "stagflation" is a significant risk in 2024. She points out that since the late 1970s, when she first started working as a market analyst, the CPI has shown a striking similarity.
The oil embargo and the Middle East wars drove up inflation in the 1970s and 1980s, and the massive spending of the U.S. government during and after the Vietnam War also contributed to the price increases. These factors make the situation today much similar to the past, with the pandemic and its subsequent recovery leading to soaring inflation, conflicts in the Middle East pushing up oil prices and supply chain issues, and ongoing government spending being a focus.
Will Compernolle, a macro strategist at FHN Financial, said it was hard to ignore a quarter's poor inflation data, but it was not necessarily indicative of future trends, as inflation could lag growth. Strong growth in the second half of last year may have driven inflation in the first quarter. ”
Compernolle added: "It's unclear how the momentum of inflation will play out, and I still think that the economy as a whole is in a better equilibrium state than it was two years ago. Inflation is similar to an inertial force, we have not yet fully understood it, and there are many different mechanisms involved in the formation of inflation. ”
This is the Fed's biggest nightmare
Following the release of the data, both US Treasury yields and inflation-adjusted yields rose to their highest levels since November. The market expects the probability of a Fed rate hike by December rising to 21.4% from 17% a day earlier.
Fitch economist Olu Sonola writes that the focus on the current US economy is a surge in inflation, and if economic growth continues to decline slowly, but inflation soars in the wrong direction again, then expectations for a Fed rate cut in 2024 will fall further.
Nick Timiraos, a well-known financial journalist known as the "new Fed news agency", wrote that the report on U.S. economic activity released on Thursday brought the latest bad news for investors and Fed policymakers, who had expected that slowing economic growth and cooling inflation would allow the Fed to start cutting interest rates this summer, but in fact the opposite was true.
Timiraos noted that the latest data suggests that US inflation is proving to be more stubborn than expected after experiencing a perfect cooling in the second half of last year.
The data suggests that the core PCE price index for March, which will be released today, could be above 0.22% year-on-year, approaching 0.3% (the consensus level expected). This means that inflationary pressures may be greater than previously anticipated. Core PCE data for January and February are also likely to be revised upwards.
You know, the problem of stagflation is the worst nightmare of every central banker, and in order to solve the problem of stagflation that occurred in the 70s of the last century, the Fed replaced two Fed chairmen, and there is no way to cure it.
In 1979, Paul Volcker raised interest rates dramatically, reaching a maximum of around 20% in the federal funds rate. Although this measure eventually brought inflation under control, it also led to a recession in 1980-1982, with unemployment exceeding 10% at one point.
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