Disco Inferno: America Could Go Back to ’70s Stagflation



“This transitory life. This phrase – taken from an old prayer for those who suffer from “turmoil, sorrow, need, disease or any other hardship” in their earthly existence – resonates in my head these days. Unfortunately, this is too applicable for too many people.

In its current use, “transient” is the modifier favored by American policymakers to describe the surge in inflation accompanying the recovery of the economy after its severe recession induced by Covid-19. Once the pressure of pent-up demand and supply disruptions dissipate, they say, the price disruptions will subside and the economy will regain its pre-pandemic health.

At first glance, it would appear that the ultimate arbiter of the economic outlook, the bond market, agrees with this assessment. Despite the surge in prices, long-term Treasury yields continue to decline, close to their lowest levels since February. This implies that the market anticipates an easing of pressure on prices. Yet much of the decline has been in real (i.e. inflation-adjusted) returns, which tend to be associated with slower expected economic growth.

But the definition of transient seems to have changed. Or maybe America’s patience is running out as what is supposed to be a brief surge in inflation persists. This is what one might conclude from questions posed to Federal Reserve Chairman Jerome Powell last week in his semi-annual testimony to Congress on monetary policy and the economy.

Powell had the misfortune of having to defend central bank policies just after the announcement of much larger than expected consumer and producer price hikes. The overall consumer price index climbed 0.9% in June, taking its increase from the previous year’s level to 5.4%, the highest since 2008, when crude oil hit a low. a record high of nearly $ 150 a barrel, about double the current price. The “core CPI,” which excludes food and energy, rose 4.5% year over year, while the producer price index jumped 7.3% . Not counting food and energy, it is up 5.4%. All of these numbers were well above the Fed’s new softer target of just over 2% annual inflation.

The steep increases rekindled memories of the bad old days of the 1970s, at least among us, the old folks who experienced the continued rise in prices back then. Certainly, much of the latest CPI increase could be attributed to anomalous factors related to the reopening of the economy, including soaring prices for used cars, hotel stays, travel tickets, and more. plane and car rentals. Thus, a resumption of the high inflation of this dismal decade should not be more likely than a return of disco.

But the comparisons are blurred by the different criteria currently used.

Joseph Carson, former chief economist at AllianceBernstein, points out that the 1970s CPI included house prices, unlike the current index. “Here is a simple illustration of the importance of including and excluding house price inflation. In 1979, the CPI rose 11.3%, which included a 14% increase in the price of existing homes. Over the past 12 months, the CPI has risen 5.4%, and the 23% increase in existing home prices is not one of them. Government statisticians created an arbitrary owner rents index (up 2.3% last year) to replace house prices, ”he writes in his Carson Report Blog.

This imputed rent is deducted from estimates of landlord rents in the tenant market, which is fundamentally different from the market for owner-occupied housing, he adds. This creates a huge error in the data. Since owner-occupied housing accounts for almost a quarter of the consumer price index, Carson assumes that the CPI would rise at double-digit rates similar to those of the 1970s if the index were calculated at ‘Ancient.

However it is measured, inflation is wreaking havoc on consumers. After the impact of rising prices, real hourly wages are down 1.7% from a year ago, according to TLR on the Economy, while real weekly wages are down by 1.4% after a 0.4% increase in the average work week. The real wages of production workers fell 2.2% and their real weekly earnings are down 1.6% when a slightly longer work week is taken into account.

Thus, workers earn less in real terms than they were then in 2020. This could help further explain the 9 million highly rated jobs that go unfilled despite continued unemployment, in addition to the others. frequently cited factors, such as generous additional unemployment. social benefits, childcare needs, and lingering concerns about Covid-19.

After taking inflation into account, real retail sales also collapse, as David Rosenberg, the eponymous of Rosenberg Research, points out. And this despite the higher-than-expected overall increase of 0.6% in June, which he said was entirely linked to inflation, with real volumes falling, and followed a downward revision of data from May to show a decline of 1.7% instead of 1.3%. originally estimated.

This means that the “shift” to the current quarter leaves the economy at a lower starting point – a mirror image of the second quarter, which started off on a good note, Rosenberg adds. After shifting roughly six years of spending on consumer durables over the past 16 months, consumers are pulling back. The latest University of Michigan survey showed that consumers’ home and auto purchasing plans fell back to 1982 levels. With the 70% of the economy represented by the collapse of consumers, combined with declines in industrial production, it is difficult to see the gross domestic product increase in the current quarter. Contrary to consensus estimates of 7% growth in the quarter, Rosenberg says the economy is on the verge of plunging into a recession.

Lower growth expectations are also evident in the decline in Treasury yields, particularly the real yields on Inflation-Protected Treasury Securities, or TIPS.

From a high of 1.74% at the end of the first quarter, the yield of the benchmark 10-year Treasury index slipped to 1.30%, a decline of 44 basis points (each equal to 1 / 100th of a percentage point). The corresponding 10-year TIPS yield fell to minus 1.03% from minus 0.64%, down 39 basis points. For 30-year maturities, the yield on long-term bonds slipped 46 basis points over this period to 1.94%, while the yield on 30-year TIPS fell by 42 basis points. As a result, real long-term interest rates are falling.

Certainly, many other factors contributed to the decline. The Fed continues to inject $ 120 billion per month into the market by buying mortgage-backed securities from the Treasury and agencies. Although low, US bond yields are attractive compared to negative overseas yields, even after hedging currency risk for foreign investors. Another factor driving rates down is strong demand for company pension plans, as discussed here last month.

The stock market also appears to be showing signs of concern. Even though major averages are close to record highs, leadership once again appears concentrated among the biggest tech growth stocks, while the rest of the pack lags behind.

In the past three months, the

Equal Weight Invesco S&P

the exchange-traded fund (ticker: RSP) is up 2.7%, well behind the 4.9% gain for the capitalization-weighted fund

SPDR S&P 500

ETF (SPY) and the gain of 5.5% for the

Invesco QQQ Trust

(QQQ), which tracks the biggest non-financial Nasdaq stocks. And the

iShares Russell 2000

ETF (IWM), which tracks small cap stocks, is down 3.0% over the same time frame.

Read more From top to bottom of Wall Street: By this key metric, the stock market is trading at Dot-Com-Era levels

In his testimony to Congress, Powell said the Federal Open Market Committee will discuss the timing of its reduction in bond purchases again at its next meeting, scheduled for July 27 and 28. Monthly purchases include $ 40 billion in mortgage-backed securities, which a number of U.S. officials and senators have questioned, given the heat in the real estate market.

In addition to the seemingly more-than-transient inflation, the panel may also have to consider the possibility of a sharper-than-expected economic slowdown, as Rosenberg argued. This could add to the worst of all possible worlds of the 1970s: stagflation.

Write to Randall W. Forsyth at [email protected]



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