• Multi-Asset & Macro
  • Multi-Strategy Target Return

Is stagflation set to make an unwanted return?

A growing chorus of experts are warning of the return of stagflation – periods of high inflation with low or negative economic growth. 

Is stagflation set to make an unwanted return?

With the US Federal Reserve (Fed) and many other central banks in the process of tightening monetary policy rapidly to combat inflation, concern the world economy is heading for trouble is mounting.

Two ex-Fed officials recently warned US interest rates will have to rise more than expected and the outcome could be a recession. The remarks came after the International Monetary Fund said a prolonged slowdown in China would have substantial global spill overs. The warning came as it slashed its growth forecast for the world’s second biggest economy this year to 4.4 per cent, well below Beijing's target of around 5.5 per cent, as its ‘zero-COVID’ policy forces much of the country into lockdown, disrupting production and curbing consumption.

In Europe too, the risk of recession appears to be growing as surging energy and food bills hammer household budgets.

Little surprise then that a growing chorus of newspaper headlines is going as far as to warn stagflation, a long-lost economic phenomenon, is about to make an unwanted return.

The recent surge in inflation has been driven by a series of supply shocks

The recent surge in inflation has been driven by a series of supply shocks, caused first by the pandemic, and more recently by the war in Ukraine and China’s zero-COVID policy. However, unless the world experiences further supply shocks, Michael Grady, head of investment strategy and chief economist at Aviva Investors, says suggestions leading economies are likely to suffer from persistent double-digit inflation alongside economic stagnation or recession are alarmist.

He points out that the combination of weaker output and sharply rising prices is highly unusual and has occurred only once before, in the 1970s, when two separate oil-price shocks (in 1973 and 1979) led to soaring inflation.

Over the past four decades, labour markets in most advanced economies have become much more flexible, while the threat of jobs being shipped abroad or automated has not gone away. That means there is far less scope for wages to continue rising in the face of slacker economic activity.

The fact that central banks have gained greater independence since the 1970s is another reason to doubt inflation will become entrenched. Among advanced economies, monetary policy needs to tighten fastest in the US, where the economy looks to be operating at, or close to, full capacity. Rapid job creation over the past two years has pushed the number of unemployed people per job opening to a record low.

By contrast, European economies are still operating some way from capacity and there is very little evidence of inflation beyond energy and food prices.

Investors need to adjust portfolios to account for both higher and more volatile inflation 

However, there are strong grounds for believing average inflation around the world will be appreciably higher over the next ten years than in the decade that followed the Global Financial Crisis and the one that preceded it. Investors need to adjust portfolios to account for both higher and more volatile inflation than they have grown accustomed to.

US interest rates may well rise higher than the market is currently anticipating. That could put pressure on the price of US government bonds, as inflation erodes the purchasing power of the fixed income they deliver.

As for equities, the combination of rapidly slowing growth, sustained high inflation and tighter monetary policy means stock selection will be critical.

Three points to remember

  • Inflation is surging in economies around the world, triggered by the Ukraine war (which has disrupted the supply of key commodities) and rocketing demand as the global economy emerges from COVID-19
  • Central banks are raising interest rates and reining in the special measures designed to help COVID-19-stricken economies combat inflation. These moves, combined with the price pressures facing consumers, are likely to cause economic growth to slow sharply
  • However, it is unlikely that we are entering an era of stagflation, and there are measures investors can take to protect portfolios

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL). Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.