There have been increasing concerns over “stagflation” risks in recent months, as economic indicators weaken and tariffs threaten to push inflation back up.
The term is used to describe the highly undesirable combination of low growth, high unemployment, and high inflation.
US continuing unemployment claims have hit the highest since 2021, while the Institute of Supply Management indices (for both the manufacturing and services sector) have fallen into contractionary territory.
The prices paid indices in these surveys hit three-year highs and long-term inflation expectations (in the University of Michigan survey) have risen above four per cent for the first time since 1993.
We’ve seen similar signs here in New Zealand too.
Despite an improvement, growth is still sluggish and some inflation indicators quietly ticking higher.
The ANZ Business Outlook survey has seen the net proportion of firms intending to raise their prices increase above 50 per cent in recent months.
That’s the highest in almost two years.
Cost indicators have also drifted up, suggesting many firms will try and recover these at the first sign of a stronger backdrop.
The recent conflict between Israel and Iran has further complicated the outlook, leading to a spike in the price of oil.
Slow growth and rising inflation are an ugly combination, and a sustained increase in oil prices wouldn’t help matters.
There’s no cause for alarm as yet, but these indicators do mirror some of the warning signs from previous periods of stagflation.
The most well-known of these was the 1970s, a decade that was mired in stagflation and was abysmal for investment returns.
US shares, corporate bonds and real estate all posted respectable, albeit below average, annual gains of 5-7 per cent.
However, none kept pace with rampant inflation, which meant that in “real” terms, investors went backwards.
It was even worse here in New Zealand, where inflation averaged 12 per cent per annum, outpacing the local sharemarket and completely eroding ten years’ worth of house price rises.
Few assets provided refuge, with gold, commodities and farmland some the only things that performed well.
Several factors contributed to this US stagflation, including high government spending and wage demands from powerful trade unions.
However, soaring oil prices were the biggest factor after producing countries cut supply in the wake of the war between Israel and a coalition of Arab states in 1973.
Rising fuel prices hit the US economy hard, leading to higher transport costs, wages, and overall prices.
During the previous decade US inflation had averaged 2.5 per cent, unemployment had fallen as low as 3.4 per cent and interest rates remained modest.
By 1974, inflation was running at ten per cent, the central bank policy interest rate was almost 13 per cent, unemployment was on its way to nine per cent and the economy was in recession.
To be clear, the 1970s was a unique period and we’re a long way from there today, despite some of the recent similarities.
However, the situation bears monitoring.
There are few winners from a weakening economy, especially if stubborn inflation puts policymakers in a bind and reduces their ability to provide support.
A central bank would typically start reducing interest rates in response to slowing economic activity, but if it sees price pressures on the horizon it might be forced to think twice.
It’s important to note that many of the negative signposts we’re seeing reflect concerns on the part of consumers and businesses, rather than the reality right now.
We need to watch oil prices, whether pricing intentions translate into higher consumer prices, and keep a close eye on how central banks deal with conflicting signals.
While today’s stagflationary risks pale in comparison to the 1970s experience, even a mild version would reshape the economic and investment backdrop.
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.
Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.