Markets
Stagflation rerun? Editor’s Note
Russia's invasion of Ukraine is sparking global price increases at a time of already-high inflation. But will worsening inflation and weakening economic growth open the door to stagflation?
$5. That’s how much I paid for a black coffee yesterday. Last week, I paid $4. What’s $1, you ask? It doesn’t sound like much, but the 25% jump in price far outstrips my last salary bump. I eavesdropped on several versions of the ‘insane price of coffee’ conversation across Sydney’s CBD this week as I waded to the office – a mixture of dismay over the price of a simple cup of joe and tips about where to find the best quality-to-price ratio. The exchange occurs in the open between friends and colleagues because it’s a daily habit that we bond over. Rarely would we bemoan the rising costs of tomatoes, but inflation is happening there too, tinned, fresh and saucy. Fuel is another big one as prices per liter push well above $2 across the state this week, hitting the pockets of families and businesses.
The big fear now is that rising costs for essentials, fears over the war raging in Ukraine, flooding on the east coast, and the prospects of higher rates depress confidence and lead households to cut back on spending. That could cause growth to slow at the same time as prices stay stubbornly high - a combination economists refer to as ‘stagflation’ (a portmanteau of ‘stagnation’ and ‘inflation’).
This highly unusual phenomenon was first recognised in the 1970s when an oil supply shock led to an extended period of higher prices but falling economic growth and rising unemployment. In the US, inflation reached 12.4% by 1980, while GDP was negative at -0.2% and unemployment rose to 7.1%. Australia experienced it too, where analysts struggled to grasp how unemployment and rising inflation could occur simultaneously (it had been assumed they could be traded off against each other). Safe to say, it’s not an economic period people miss, although the clothes were fantastic (and back in fashion).
So, could it happen today? Analysts are divided but people are taking it more seriously than they were two weeks ago. Whispers of a stagflation rerun appeared in economic circles in October 2021 with US GDP running at a paltry 2% (alongside a supposedly rebounding economy) as inflation climbed to 6.2%. Now, Russia’s invasion of Ukraine is constraining supply and pushing up prices of commodities around the world at a time when economies were already grappling with the highest inflation in decades (jumping to 40-year highs of 7.9% in the US this week). Economists are on edge again as analysts downgrade their growth forecasts.
Commodities exposed to Russia/Ukraine have soared the most this year
Europe’s largest asset manager Amundi stated last week that Russia’s invasion of Ukraine “marks a further step in the road back to the 70s”. GSFM investment specialist Stephen Miller also has stagflation on the mind, telling my colleague Lewis Jackson: “At the moment, things look ok, but there are reasons to be worried. I’m not saying this is necessarily a rerun, but there are eerie parallels.” Stock markets in Europe are already seeing the fallout of a ‘stagflationary stock’ as the much-anticipated growth to value rotation stalls and fears rise that the conflict will put a brake on the region’s economy.
But not everyone is so sure. David Sekera, chief US markets strategist at Morningstar told Jackson he is more sanguine about the risk, citing robust growth in the US and confirming his belief that inflation will subside this year as “supply chain bottlenecks ease and consumers switch spending from goods to services”. It’s worth noting that inflation is high, on a relative basis, but remains well beneath the peaks we saw in the 1970s. Unemployment is similarly low by historical standards. Australian households are also hoarding historically high levels of cash, but then again, are they confident enough to spend it?
Australia’s economic outlook is unclear, a factor that was present in the statements for many ASX-listed companies during February reporting season. While few are crying stagflation today, it’s something to keep an eye on because it would be a real headache for investors if it eventuates. As economies emerged from the pandemic, we all knew there were going to be bumps in the road. But the question for investors is whether the bumps are temporary or persistent. Australia only reports CPI numbers on a quarterly basis, with the next set due at the end of April, but you can notice the prices going on around you and your own emotional response. Let’s hope coffee prices stay where they are.
More from Morningstar this week:
Woodside and Santos soar as investors return to energy stocks
"There's been a big rotation in markets": Value surges as growth stumbles
Australia’s commodity boom shows little sign of fading: Charts of the week