No Stag, Sticky Flation

It seems that every few years, the term “stagflation” gets floated around to describe the current and/or prospective U.S. macro landscape. It’s easy to oversimplify this characterization, but it is very important to not only provide perspective for what stagflation really looked like from a historical perspective but also underscore how the present situation either differs or is similar to any prior episode of this economic phenomenon.

Fed Chairman Powell was asked to weigh in on the stagflation question at last week’s May Federal Open Market Committee (FOMC) presser. Interestingly, he stated: “I was around for stagflation” in the 1970s and added, “so I don’t see the ‘stag’ or the ‘flation.’” In our opinion, the Fed Chair hit on a critical point of the argument, i.e., the historical perspective. Just because the economy may not be running on all cylinders and price pressures are elevated compared to pre-COVID-19, it doesn’t mean the economy is in, or headed for, stagflation.

Let’s provide some much-needed historical context to the discussion. Technically, one could focus on the 1974–1975 period to highlight the differences between then and now. During this mid-1970s timeframe, real gross domestic product (GDP) was in negative territory until the second quarter of 1975, the unemployment rate reached as high as 9%, and the annualized core Consumer Price Index (CPI) topped out at +11.7%. Currently, real GDP was +1.6% in Q1, the jobless rate is under 4%, and core CPI is rising at a year-over-year clip of 3.8%.

So, what gave rise to this renewed stagflation talk? More likely than not, the catalyst was the recently released report for Q1 GDP. The Bureau of Economic Analysis (BEA) reported that real GDP rose less than the expected +1.6% we just mentioned, and the core Personal Consumption Expenditure (PCE) Price Index increased by a greater-than-forecasted +3.7%. In other words, growth slowed to its lowest level in almost two years while inflation posted its first acceleration in a year.

The “sticky” aspect of inflation has been on display since the end of last year, and over the last few months, one could argue it is becoming less surprising that “the last mile” toward the Fed’s 2% target is proving to be more difficult. In our opinion, the slowdown in growth, at least from a headline perspective, was the newer piece of the puzzle.

However, after going under the hood of the GDP numbers, one discovers that the underpinnings of the economy remained solid to begin 2024. When looking at the economy, we have previously written about how one should think of the growth engine as having five cylinders: personal consumption, investment, trade, inventories and government spending. The trade and inventories components can be volatile from quarter to quarter, and while government spending has definitely increased in the post-COVID-19 world, it does not always provide a positive contribution on a quarterly basis.

That brings us to a measure of growth that goes to the root of the economy: final sales to private domestic purchasers. This component strips out trade, inventories and government outlays, leaving us with household spending and business and residential investment. In Q1, this gauge rose 3.1%, or nearly double the real GDP reading. In addition, it has also now expanded by 3%, or more, over the last three quarters.

Hence, while you may not always agree with Powell, this time around, he appears to have been more “spot on” from a historical perspective.

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