October inflation cooled more than expected, but it’s still close to 40-year highs. Here’s what 5 experts have said about the risk of stagflation hitting the US economy

Paul Volcker, former Fed Chair 1979 to 1987.

  • Inflation cooled in October, but prices have been elevated for over 20 months now, raising concerns of stagflation.
  • That means the economy could be slammed with high unemployment, low growth, and persistent inflation – as well as a steep drop in stocks.
  • Here’s what five experts have said about the risks of stagflation and why markets should be more concerned.

Inflation cooled more than expected in October’s Consumer Price Index report – but prices are still well above the Fed’s 2% target, and they’ve been above-target for 20 months now.

That “sticky” inflation has sparked fears of stagflation, a dreaded scenario where high inflation gets entrenched into expectations, slamming the economy with a whirlwind of slow growth, high unemployment (and yes, high prices).

Those conditions defined the US economy throughout the 1970s and early 1980s, pushing the Fed to hike rates past 19% in the early 1980s. That’s the tightest monetary policy on record, and it spurred a recession and a stunning crash in the stock market.

Luckily, evidence for another potential crisis is mixed, and October’s cool-down in inflation should help soothe some fears. Five-year expectations of inflation are still hovering around the 2% level, and experts have pointed out that inflation often lags behind the official statistics – meaning that prices could be overstated, and are even lower than the latest CPI suggests. Hiring is still tight, and unemployment remained in check at 3.7% in October, which means the labor market has held up amid the Fed’s scramble to rein in prices.

As investors digest mixed signals on the direction of the economy, here’s what five experts have said about the risk of stagflation descending on the US economy.

Henry Allen, Deutsche Bank analyst

Deutsche Bank

Despite inflation cooling in recent months, markets are seriously underpricing the risks of returning back to 70s-style stagflation, Deutsche bank analyst Henry Allen wrote in a recent note.

Allen pointed out that inflation has remained high for a significant portion of this year, and while headline inflation is on the downtrend, “sticky” prices – prices for goods and services that don’t change frequently – were still accelerating in September’s inflation report, and barely cooled by .03% percentage points in October. Together, those indicators are “seriously bad news,” as they’re major omens for inflation expectations getting embedded in the economy.

If inflation remains persistent, that would result in an even higher interest rate from the Fed, Allen warned, which could spell trouble for stocks: “If the experience of the 1970s repeats, investors are in for a prolonged period of negative real returns for both bond and equity,” he said.

Mohamed El-Erian, Allianz chief economic advisor

Mohamed El-Erian
Mohamed El-Erian

Top economist Mohamed El-Erian believes the US is already headed into a stagflationary crisis, as seen by low levels of growth and high levels of inflation this year.

“We are slowly slipping into stagflation,” El-Erian said in a recent interview with Bloomberg. “We may not end up doing enough on the inflation side and then end up in a recession for Europe, near recession for the US and for China.”

El-Erian has sounded the alarm on rising inflation since 2021, and has become a loud critic of the Fed’s policy response, and of the central bank’s insistence that rising prices were “transitory” before aggressively hiking rates this year. That raises the probability of a downturn – but stagflation risks mean the Fed can’t back down from its aggressive rate-hiking regime, he said, warning it would be another policy mistake to stop Fed tightening at this point.

“I don’t think they can stop now. Because their credibility is so damaged that if they were to stop now, people would immediately say, ‘This is the Federal Reserve of the 1970s. This is the flip-flopping Fed, and we will have prolonged stagflation,'” he warned in an interview with New York Magazine in October. “I’ll tell you that the consequences of that are worse than the consequences of the Fed continuing.”

“Dr. Doom” Nouriel Roubini, NYU Stern economics professor

roubini

Roubini, who has earned a reputation as Wall Street’s top doomsayer, warned high inflation levels and high debt means the US could be slammed by a stagflationary debt crisis – a Frankenstein-style crash that combines aspects of 70s stagflation and the ’08 financial crisis.

That means low growth, high unemployment, and a painful recession in the US, he warned. In a recent interview with Fortune, he estimated that a mild recession could send the S&P 500 down another 10%, and a severe recession could send the index falling 30% to the 2,700 level. Bonds, credit, and other assets could also see a crash, topping on more damage.

That market rout could also last for years, he warned, due to high levels of debt and ongoing supply issues around the world, which could delay any recovery for the market.

“We might be closer to a period like we saw between 1973 and 1982, where stocks dropped and stayed very, very low for a long time … We could have a long-term crash,” Roubini said, adding that its severity would be comparable to what was seen in 2008.

Steve Hanke, Johns Hopkins University economics professor

Steve Hanke Johns Hopkins finance class

The Fed could easily drive the US into a stagflationary crisis next year, Hanke said, given elevated inflation and the high prospects for an incoming recession. In a recent op-ed for the Daily Caller, the top economist pointed to a contraction in the M2 money supply this year, which includes all cash, checking, and savings deposits in circulation. That’s a major precipitator of a recession, he said, calling a downturn in 2023 “baked in the cake.”

“Thanks to the Fed’s monetary mismanagement, broad money (M2) in the US has contracted by 1.1% in the last 7 months,” he tweeted in early November. “With that contraction, a recession is right around the corner. In 2023 we will see persistent inflation & a recession – a STAGFLATION,” Hanke warned.

Michael Hartnett, Bank of America chief global stock strategist

Bank of America
A sign hangs above a Bank of America branch in the Financial District on November 1, 2011 in Chicago, Illinois. Bank of America Corp. has reportedly announced they will drop its plan to charge customers a $5-per-month fee for making purchases with their debit cards.

The US has already been slammed with stagflation this year, Hartnett’s team of strategists said in a note earlier this month.

“Inflation and stagflation was unanticipated in 2022… hence the $35 trillion collapse in asset valuations,” the note said. In a separate note, Bank of America warned investors to prepare for the scenario that the next recession is stagflationary, given that it takes around a decade on average for a developed country to bring inflation back down to 2%, once prices pass the 5% threshold.

But it doesn’t necessarily mean prolonged losses for the stock market, Hartnett’s team said. Relative returns in 2022 closely follow what was seen in 1973 to 1974, the years when the inflation shock began to ease in. In the 70s, that prompted stocks to enter “one of the greatest bull markets of all time” – meaning that a major rally could soon take hold and spark a recovery for the market.

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