Supply chain disruptions sweeping major economies have reawakened an old nemesis for investors: stagflation.
Anxiety over rising inflation has been ever-present in markets this year. But with oil topping $80 a barrel, global food prices a third more expensive than they were a year ago and other commodities at decade highs, investors say a longer-than-expected inflationary surge is coinciding with a slowdown in growth — and making it worse.
Economists and investors play down comparisons with the aftermath of the 1970s oil shock, which gave rise to the term “stagflation”. Then, inflation and interest rates ran into double digits, unemployment soared and GDP recovered only slowly from repeated setbacks.
But with energy bills now rocketing, many worry about a growth slowdown at a time when central banks are edging towards lifting interest rates in a bid to keep a lid on longer-term inflation.
“The conversation around inflation has definitely shifted,” said Seema Shah, chief strategist at Principal Global Investors. “There’s still a broad agreement that a lot of it is transitory, but we still think it will last well into 2022 and really start to hit consumer spending.”
“It’s not the 1970s, but this is modern-day stagflation.”
Signals from the Federal Reserve and Bank of England last week that they could soon begin lifting rates have fuelled a big bond sell-off over the past week and a half. But in contrast to the “reflation” trade at the start of this year, stocks have been unable to draw comfort from the prospect that tighter monetary policy will be accompanied by accelerating growth.
Ample evidence suggests that the supply shock reverberating around the world, combined with outbreaks of the Delta variant of coronavirus, is tempering the recovery in growth.
Data released this week pointed to a sharp slowdown in Chinese manufacturing, as regulatory pressures and high energy prices shut down some production. Business surveys from the US, UK and eurozone suggest that activity has slowed as delivery times lengthened and backlogs built up.
Selling activity spilled over into equity markets this week after data showed that US consumer confidence had dropped to a six-month low in August.
The UK has found itself at the sharp end of stagflationary concerns, with a surge in energy prices compounded by driver shortages that left petrol pumps running dry.
While revised data show activity bounced back faster than thought over the summer, the recovery now appears to be faltering. The Bank of England’s governor Andrew Bailey acknowledged this week that supply bottlenecks and labour shortages were worsening, and could hold down growth and fuel inflation for some months to come.
“The recovery has slowed and the economy has been buffeted by additional shocks,” he said in a speech to the Society for Professional Economists.
Concerns over growth are one reason the pound has not benefited from a sharp rise in UK government bond yields, as they typically do, after Bailey signalled that a rate rise could come as soon as this year. Instead, sterling has slumped to its lowest level of 2021 against the dollar, as some investors fear that early rate increases could choke off a fragile recovery.
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“If it is stagflation, central banks are in a bind,” said Jim Leaviss, head of public fixed income at M&G Investments. “Hiking will reduce demand a little bit and strengthen the currency. But it will have no impact on supply chain issues [ . . .] it won’t bring back lorry drivers.”
That dilemma — shared by other big central banks — could threaten buoyant equity markets, according to Mohamed El-Erian, chief economic adviser at Allianz.
“Central banks will be torn between reacting to the ‘stag’ and the ‘flation’,” he said. “That’s a world where investors’ confidence in policymakers is shaken, and the backstop they’ve had over the past decade isn’t there any more.”
Vicky Redwood, senior economic adviser at consultancy Capital Economics, said the UK’s “stagflation lite” was visible in many countries — with the surge in inflation coming earlier in the US, but growth now slowing there too as a result of the spread of the Delta coronavirus variant.
But inflation should start to ease in 2022 and the situation was still “a long way off anything like the 1970s,” she said, adding: “we won’t see inflation get into the system like we did then.”
Others warn, however, that there is no sign yet of the strains on supply chains easing, and that the world could be heading for a more sustained period of tepid growth and higher inflation than policymakers have been predicting.
“It’s a global problem,” said Kallum Pickering, economist at Berenberg, arguing that companies had little visibility over “very complicated supply chains” and disruption could last much longer than thought.
If supply chain problems continued for a further six to 12 months, while consumers still had job security and were willing to pay for the goods they wanted, he said: “the whiff of stagflation might be more of a stench”.
Additional reporting by Federica Cocco