Stagflation Possibility Increases as Inflation Expectations Rise

Concerns Over Inflation

There have been recent discussions about how Federal Reserve President Jerome Powell's rush to cut rates before November 5, in an effort to support Kamala Harris's re-election, might have triggered a resurgence of the Arthur Burns "galloping inflation" Fed. This is particularly concerning as recent inflationary prints suggest that the Fed is easing aggressively even as inflation continues to rise.

Factors Affecting Inflation and Rates

Jim Reid, Deutsche Bank's chief credit strategist, noted that US 5-year inflation swaps have seen their "largest 5-week climb since just before SVB's collapse in March 2023." However, the 50bps Fed easing is not the only factor that has altered the inflation and rates outlook. Other factors include expectations of the ECB becoming more aggressive, renewed geopolitical risk, potential large China stimulus turning the Oil price higher, a strong payrolls report, and generally firm US data, including a surprise increase in the CPI.

Rising Home Prices and Inflation Expectations

Given these dynamics, it's not surprising that the Fed has launched an aggressive easing cycle at a time when stock prices are at all-time highs, wage inflation is around 5%, and home prices are rising at an astonishing 6%. The latest monthly survey of consumer expectations from the NY Fed found that inflation expectations rose at both the three-year horizon (from 2.5% to 2.7%) and the five-year horizon (from 2.8% to 2.9%).

Delinquency Fears

While inflation expectations rose, sentiment about the broader economy worsened as perceptions among households that they might become delinquent on debts increased last month to the highest levels since April 2020. The anticipated probability of missing a minimum debt payment over the next three months rose to 14.2% in September, marking the fourth straight month of increases. This was most pronounced for respondents between ages 40 and 60 and those with annual household incomes above $100k.

Stagflation

The latest data confirms the view that the US economy is becoming increasingly split as some households do well while others are getting crushed by rising prices, slower growth, and higher unemployment. This is indicative of stagflation. While the surge in the stock market has helped propel overall household net worth to a record over the past few months, many Americans do not own any equities and have instead been accumulating debt in recent years amid elevated interest rates.

Consumer Perceptions

The increased odds of delinquency were mirrored in a broader deterioration of perceptions about households’ current financial situations, with fewer consumers reporting being better off and more reporting being worse off than a year ago. Year-ahead household income and spending growth expectations declined by 0.1 percentage point to 3.0 percent and 4.9 percent, respectively.

Job Market Expectations

There was slightly more optimism in consumers' labor market expectations, where the probability of leaving one’s job voluntarily in the next twelve months increased to 20.4% from 19.1%, and the mean perceived probability of finding a job in the event of job loss increased to 52.7% from 52.3% in August.

Government Debt and Interest Rates

Interestingly, median year-ahead expected growth in government debt declined by 1.1 percentage points to 8.0%, reaching the measure’s lowest level since February 2020. However, the mean perceived probability that the average interest rate on saving accounts will be higher 12 months from now decreased by 1.5 percentage points to 25.1%. This suggests that about 25% of households are unaware that the Fed is now cutting rates and rates on savings accounts will be much lower in 12 months.

Stock Market Expectations

Lastly, the mean perceived probability that U.S. stock prices will be higher 12 months from now increased by 1.0 percentage point to 40.3%. It was unclear how many bulls also expected lower rates in the coming year.

Bottom Line

Overall, the survey paints a picture of a stagflationary economy, which is not what the Fed might have expected to see several weeks into the first easing cycle since the global economy was shut down by a genetically engineered flu virus in 2020. This situation raises complex questions about the state of the economy and the effectiveness of the Fed's strategies. What are your thoughts on this matter? Feel free to share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is available every day at 6pm.