US economy could be flirting with stagflation

With US economic growth slowing while inflation remains stubborn, talk has emerged of the dreaded condition known as stagflation.

The term stagflation is generally attributed to Iain Macleod, a British Conservative Party politician who became chancellor of the exchequer in 1970. He used the word in a speech to Parliament in 1965 during a period of simultaneously high inflation and unemployment in the UK.

"We now have the worst of both worlds — not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of 'stagflation' situation."

The third component in stagflation is high unemployment, although the US economy has not experienced that recently, with the most recent jobless rate at 3.5 percent. However, the tech industry has laid off more than 185,000 workers at 629 companies so far this year, according to tech layoff-tracking website layoffs.fyi.

In the 1970s, federal budget deficits boosted by military spending during the Vietnam War; social spending programs; and the collapse of the Bretton Woods agreement weakened the economy. The 1944 agreement effectively ended in 1971, when the United States ceased convertibility of the US dollar to gold, essentially making the dollar a fiat currency.

"These issues were compounded by a tripling in crude oil prices as a result of the Arab oil embargo, followed by a near-tripling at the decade's end as the US embargoed oil from Iran," according to investopedia.com. "Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s oil crisis."

"Stagflation by far is the worst-case scenario," Seema Shah, chief global strategist at Principal Asset Management, told the Bloomberg Surveillance Podcast on Friday.

Twitter user "Padrone", an econometrician in Johannesburg, posted: "Stagflation is a real problem for policy makers because the Central Bank can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. It can't do both at the same time."

The US economy grew at a sluggish 1.1 percent annualized pace over the three months ending in March, according to the Commerce Department's first estimate of first-quarter GDP growth released on April 27. That is a drop from the 2.6 percent advance over the fourth quarter of 2022 and below the forecast of 1.9 percent growth.

The personal consumption expenditures (PCE) index was up 4.2 percent in March, according to data from the Commerce Department released on Friday, matching the Wall Street forecast. The PCE index is the Federal Reserve's preferred inflation gauge.

The increase in prices was lower than the 5 percent rise in February, but it's still double the Fed's 2 percent target for inflation.

Chris Zaccarelli, chief investment officer of Independent Advisor Alliance, called the recent data "the worst of both worlds, with growth down and inflation up", reported Fortune.com.

The core PCE inflation rate, which excludes food and energy, rose 0.3 percent last month to 4.6 percent, above the 4.5 percent expected.

"Core is very sticky, and that is not good news for the Fed," said chief economist Eugenio Aleman at Raymond James, reported MarketWatch.

The CME Group's FedWatch is now pricing in an 85 percent chance of a 25-basis- point rate hike by the Federal Reserve when it concludes its two-day meeting on Wednesday.

That would move the fed funds rate to a range between 5-5.25 percent, making it the 10th consecutive increase in a cycle that started when interest rates were around zero.

"The last thing the Federal Reserve wants to be doing is raising rates as the economy begins to grind to a halt and potentially exacerbating the situation," said Marcus Brookes, CIO at Quilter Investors, reported TheStreet.com.

"The coveted soft landing is looking increasingly difficult to achieve, and we are now getting towards a position where the market may become concerned that stagflation could be a likely possibility," he said. "The next set of inflation statistics are going to be crucial for the subsequent moves by the Fed."

In a tweet early Sunday, Twitter and Tesla CEO Elon Musk wrote: "Fed data has too much latency. Mild recession is already here. It's not like just the canary in the coal mine (SVB) died, one of the staunchest miners (Credit Suisse) died too & the cemetery is filling up fast! Further rate hikes will trigger severe recession. Mark my words."

On Monday, the US banking industry saw some more drama when the Federal Deposit Insurance Corporation announced that it had seized First Republic Bank in California, which then was auctioned to JPMorgan Chase.

"To protect depositors, the FDIC is entering into a purchase and assumption agreement with JPMorgan Chase Bank … to assume all of the deposits and substantially all of the assets of First Republic Bank," the FDIC said in a statement.

The New York financial services giant will pay $10.6 billion to the FDIC as part of a deal to take control of most of the San Francisco-based bank's assets and get access to First Republic's wealthy client base.

JPMorgan will assume all of First Republic's $92 billion in deposits — both insured and uninsured. It is also buying most of the bank's assets.

It will cost the FDIC about $13 billion, according to the regulator's initial estimate. FDIC funds come from member banks' insurance dues.

Dennis Kelleher, president and CEO of Wall Street reform group Better Markets, said the auction's outcome showed "unhealthy consolidation, unfair competition, a dangerous increase in too-big-to-fail banks — all while harming community banks, small business lending, and economic growth."

Larry Summers, a Harvard professor and economist who was treasury secretary during the Clinton administration, said on Bloomberg's Wall Street Week that "we've got a bit of a stagflationary problem developing where we have base inflation that's well above target". He said inflation won't return to the target level "without a meaningful slowdown in the economy".

Reuters contributed to this story.

hengweili@chinadailyusa.com