Wall Street economists have been warning about the toxic combination of slowing economic growth and high inflation – also known as stagflation – for more than a year now.
But on Monday, Jefferies chief financial economist Aneta Markowska argued that the United States will avoid a resumption of 1970s stagflation in the coming quarters.
“It’s time to ditch the recession narrative and replace it with ‘stronger for longer.’ Stagflation is over, Goldilocks is in,” she wrote in a research note.
Inflation, as measured by the consumer price index (CPI), hit a new four-decade high of 9.1% in June, but Markowska believes falling commodity prices and healing supply chains will help reduce sky-high consumer prices over the next three years. at six months.
That should “set the stage” for a rebound in consumer spending, pushing real gross domestic product (GDP) up more than 3% in the third quarter, she said. It would be quite a turnaround after GDP contracted in the first and second quarters, leaving many wondering if the United States is already in the midst of a recession.
Markowska went on to say that this week’s CPI data will show June as the peak of US inflation, meaning the Federal Reserve will be able to slow the pace of its aggressive interest rate hikes until the end of the year. The central bank has raised rates four times this year in an effort to curb high consumer prices, including an outsized 75 basis point hike in July. And most economists expect the rate hikes to continue.
Markowska agrees the Fed will be forced to keep raising rates, but said it won’t need to be as aggressive as many on Wall Street expect.
Still, she noted that core inflation, which excludes volatility in food and energy prices, is likely to remain high through 2023. Even if the prices of plane tickets and used cars – that fueled inflation during the pandemic – are beginning to decline, Markowska says there are forces that will keep underlying inflation above the Fed’s 2% target rate for some time.
“We believe there is a lingering component to inflation due to housing and labor shortages that won’t be resolved anytime soon,” she said. “We expect these two forces to put a floor below core CPI around 4%.”
In an interview with Fortune, Markowska also warned that the US economy will experience a recession as the Fed continues its fight against persistent underlying inflation, but not anytime soon.
“I don’t buy this idea that a recession is imminent, but I do think a recession is inevitable,” she said. “That will be the price we will have to pay, at some point, to get back to 2% inflation. But I don’t think it’s just around the corner.
Markowska also said the recent decline in commodity prices and inflation expectations are not the result of Fed interest rate hikes, as central bank policies typically take some time to have an impact. on the economy. Until this impact is felt and corporate profit margins take a hit, a recession in the United States is unlikely. But that doesn’t mean it won’t come.
Markowska said the Fed will be forced to raise interest rates to a point where unemployment will rise significantly in 2023 if it hopes to reduce underlying inflation to near its target level. This will likely trigger a recession.
“I think in order to get that sticky component of inflation down, they [the Fed] have to create slack in the labor market, they have to really drive up the unemployment rate. And frankly, I don’t think 4% unemployment is good enough,” she said, adding that the Fed might be forced to push the unemployment rate towards 6 or 7% to really beat the crisis. inflation.
For investors, this means that the current rally in equities is a “bear market trap”, but investment returns over the next few months could be better than expected.
“I think ultimately it will be a bear market trap,” she said. “But again, I don’t think it’s [the rally] is going to end tomorrow, because we still have at least two to three months of really good data ahead…so this could be an even bigger bear market than most people think.
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