The US economy may be barrelling towards stagflation, an outcome worse than recession
- The first-quarter GDP report surprised investors with disappointing growth, while consumer prices kept rising.
- The provides the backdrop for stagflation, which can’t be combated with rate cuts.
- The 1970s offer a warning of what could happen if inflation spirals out of control.
The latest GDP and inflation readings were what investors were least eager to see, and could hint at serious trouble ahead.
“This was a worst of both worlds report – slower than expected growth, higher than expected inflation,” wrote David Donabedian, chief investment officer of CIBC Private Wealth US.
First-quarter growth fell well behind estimates, rising at an annualized rate of 1.6%, according to the Bureau of Economic Analysis. Not only is that far under forecasts of 2.5%, but it also fails to live up to the 3.4% increase achieved in the fourth quarter.
While such a cooldown would usually bolster calls for interest rates to start easing, the report noted a hotter-than-expected rise in consumer prices as well. That puts serious limits on the Federal Reserve’s ability to take action, as the central bank has made clear it needs inflation to climb lower before any rate cuts can happen. Stocks — which have long priced in those cuts — sold off sharply.
It’s also bad news for the economy, as sputtering growth and higher prices are the key ingredients for stagflation, which is characterized by economic listlessness and stubbornly elevated inflation over a prolonged period. Such a scenario that can be even harder to combat than a recession, because of the dynamic outlined above: the Fed’s hands are largely tied.
America’s last dalliance with stagflation came in the 1970s. The precedent can offer a glimpse into how the US economic picture could unfold, and makes it clear why economists are desperate to avoid a re-run.
