Are we headed for the dreaded Stagflation?

binsfeldcyhawk2

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Oct 13, 2006
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Dreaded stagflation word used :(

The Conference Board forecasts that economic weakness will intensify and spread more broadly throughout the US economy over the coming months with a recession to begin before the end of 2022. This outlook is associated with persistent inflation and rising hawkishness by the Federal Reserve. We forecast that 2022 Real GDP growth will come in at 1.5 percent year-over-year and 2023 growth will slow to zero percent year-over-year.

While we do not believe the US economy slipped into recession earlier this year – primarily due to the extremely tight labor market – we expect that a broad downturn is on the way. We upgraded our forecast for Q3 2022 from 0.3 percent to 0.5 percent – largely due to an upward revision in the previous quarter’s GDP data and several indicators pointing to a slight improvement in economic momentum at the beginning of the quarter. However, these improvements will be short-lived as economic growth continues to cool now in Q4 2022. Furthermore, reflecting a more aggressive interest rate outlook by the Federal Reserve, we further downgraded our forecast for Q4 2022 and much of 2023. While consumption growth isn’t likely to dip below zero until Q4 2022, we expect non-residential investment to retreat more rapidly under the weight of higher interest rates. Residential investment will continue to contract as the housing market works to find a new lower equilibrium.

Weakening economic growth seen over the course of 2022, coupled with persistently high inflation readings, are consistent with a stagflationary environment. While easing supply-side constraints and a more hawkish monetary policy should help cool inflation over the coming quarters, rising interest rates will tip the US economy into a broad-based recession. This contraction will impact extremely tight labor markets and drive the unemployment rate higher. Still we anticipate the jobless rate may peak at 4.4 percent, which by historical standards is quite low. This expectation reflects severe labor shortages, especially in in-person services sectors, that may continue despite the recession. We expect the coming recession to be relatively short and somewhat mild, and that the US economy will emerge from the slowdown in 2023 still grappling with inflation well above the Fed’s 2-percent target. This period will also exhibit stagflationary characteristics – though not as severe as those seen presently.

Risks to our forecast remain plentiful. On the downside, (1) the Federal Reserve could hike more aggressively than expected, (2) the housing market could see a major correction, and (3) inflation could be even more persistent than forecasted. All three of risks could result in a longer and deeper contraction in 2023. The only meaningful upside risk, in our view, is a rapid and unexpected decline in inflation. However, even if this were to occur, we do not believe a growth slowdown would be avoidable.

 

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