The 'S' Word: Do We Already Have Stagflation?

For strange people like me, who find markets and the economics behind them fascinating, we are living in a remarkable time. Up until recently, most people thought they knew what both a healthy economy and a recession looked like in terms of the data. Good times were marked by a strong jobs market, which inevitably came when the economy was growing, and a recession was when growth turned negative, and unemployment became a problem. The former was a time to buy, the latter to take a more cautious, defensive approach to trading and investing.

Oh, how I miss those simple days! What we are seeing right now is anything but simple. We have had two consecutive quarters of negative GDP growth, which would normally signal a recession, but we have a strong jobs market despite that. Weekly jobless claims, which came out this morning, are not usually a big deal. They are weekly, of course, so tend to be volatile, with longer-term trends mattering much more than any one print, but this morning’s numbers were jarring all the same. They showed another big decrease in workers registering as unemployed, which in normal times would be good news, and would cause a rally in stocks.

Today, however, stock market futures dropped on the news, taking the major indices back towards the lows hit before yesterday’s strong rally. The problem is that with inflation and the Fed’s response to it being the big story as far as traders are concerned, a strong jobs market is not considered good news at all.

If you think that good news being bad is confusing, the revisions to some second quarter numbers that also came out this morning are even more so. They confirmed that in Q2, GDP declined for the second consecutive quarter, while consumer spending rose and core PCE -- the Fed’s favorite inflation indicator -- jumped again. So, let’s get this straight. We have a situation where the economy is supposedly shrinking, but jobs are plentiful, people are spending money, and prices are rising.

In terms of accepted economic theory, those things should not be happening simultaneously. The numbers show that they are, so what's going on?

Well, the obvious contributing factor is that Covid created a situation never seen before when economies around the world all shut down, suddenly and almost completely. The complete shutdown didn’t last long, and the bounce back was rapid, but that created its own problems. An economy going from 100 to 0 in a week or so is disruptive, but so is trying to go from 0 back to 100 in a short time, and for economists, traders, and investors, the uniqueness of the situation meant there were no reference points to help understand what that meant or, more importantly, how policy should be shaped to deal with it.

All of that explains how we got here to some extent, but it doesn’t tell us where we actually are. There is, however, a word for it: stagflation. Stagflation is when an economy is experiencing stagnation and inflation at the same time. That is what we seem to have now, even if the powers that be are reluctant to use the word. If we don’t admit to it, though, we can’t deal with it.

Stagflation doesn’t have to end in a disastrous, painful recession. It will take some delicate handling by the Fed, and a bit of luck, if we are to avoid that, but the first step is to recognize it for what it is. Maybe it is time to face the facts and start using the scary word.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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