Stagflation fears intensify in indicators of slowing development

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Provide chain disruptions sweeping main economies have reawakened an outdated nemesis for traders: stagflation.

Anxiousness over rising inflation has been ever-present in markets this yr. However with oil topping $80 a barrel, international meals costs a 3rd dearer than they had been a yr in the past and different commodities at decade highs, traders say a longer-than-expected inflationary surge is coinciding with a slowdown in development — and making it worse.

Economists and traders play down comparisons with the aftermath of the Seventies oil shock, which gave rise to the time period “stagflation”. Then, inflation and rates of interest bumped into double digits, unemployment soared and GDP recovered solely slowly from repeated setbacks.

However with vitality payments now rocketing, many fear a couple of development slowdown at a time when central banks are edging in the direction of lifting rates of interest in a bid to maintain a lid on longer-term inflation.

“The dialog round inflation has positively shifted,” mentioned Seema Shah, chief strategist at Principal International Traders. “There’s nonetheless a broad settlement that numerous it’s transitory, however we nonetheless assume it would final effectively into 2022 and actually begin to hit client spending.”

“It’s not the Seventies, however that is modern-day stagflation.”

Indicators from the Federal Reserve and Financial institution of England final week that they might quickly start lifting charges have fuelled a big bond sell-off over the previous week and a half. However in distinction to the “reflation” commerce at first of this yr, shares have been unable to attract consolation from the prospect that tighter financial coverage will likely be accompanied by accelerating development.

Ample proof means that the availability shock reverberating around the globe, mixed with outbreaks of the Delta variant of coronavirus, is tempering the restoration in development.

Knowledge launched this week pointed to a pointy slowdown in Chinese language manufacturing, as regulatory pressures and excessive vitality costs shut down some manufacturing. Enterprise surveys from the US, UK and eurozone recommend that exercise has slowed as supply occasions lengthened and backlogs constructed up.

Line chart of Manufacturing purchasing Managers Index (Above 50 = a majority of businesses reporting expansion) showing Business surveys suggest the global recovery is now losing momentum

Promoting exercise spilled over into fairness markets this week after knowledge confirmed that US client confidence had dropped to a six-month low in August.

The UK has discovered itself on the sharp finish of stagflationary considerations, with a surge in vitality costs compounded by driver shortages that left petrol pumps operating dry.

Whereas revised knowledge present exercise bounced again sooner than thought over the summer time, the restoration now seems to be faltering. The Financial institution of England’s governor Andrew Bailey acknowledged this week that offer bottlenecks and labour shortages had been worsening, and will maintain down development and gas inflation for some months to return.

“The restoration has slowed and the economic system has been buffeted by further shocks,” he mentioned in a speech to the Society for Skilled Economists.

Considerations over development are one motive the pound has not benefited from a pointy rise in UK authorities bond yields, as they sometimes do, after Bailey signalled {that a} price rise might come as quickly as this yr. As an alternative, sterling has slumped to its lowest degree of 2021 in opposition to the greenback, as some traders worry that early price will increase might choke off a fragile restoration.

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“Whether it is stagflation, central banks are in a bind,” mentioned Jim Leaviss, head of public mounted revenue at M&G Investments. “Mountaineering will scale back demand just a little bit and strengthen the forex. However it would haven’t any impression on provide chain points [ . . .] it gained’t convey again lorry drivers.”

That dilemma — shared by different large central banks — might threaten buoyant fairness markets, in line with Mohamed El-Erian, chief financial adviser at Allianz.

“Central banks will likely be torn between reacting to the ‘stag’ and the ‘flation’,” he mentioned. “That’s a world the place traders’ confidence in policymakers is shaken, and the backstop they’ve had over the previous decade isn’t there any extra.”

Vicky Redwood, senior financial adviser at consultancy Capital Economics, mentioned the UK’s “stagflation lite” was seen in lots of international locations — with the surge in inflation coming earlier within the US, however development now slowing there too on account of the unfold of the Delta coronavirus variant.

However inflation ought to begin to ease in 2022 and the state of affairs was nonetheless “a good distance off something just like the Seventies,” she mentioned, including: “we gained’t see inflation get into the system like we did then.”

Others warn, nevertheless, that there isn’t any signal but of the strains on provide chains easing, and that the world might be heading for a extra sustained interval of tepid development and better inflation than policymakers have been predicting.

“It’s a world downside,” mentioned Kallum Pickering, economist at Berenberg, arguing that firms had little visibility over “very sophisticated provide chains” and disruption might final for much longer than thought.

If provide chain issues continued for an additional six to 12 months, whereas customers nonetheless had job safety and had been keen to pay for the products they wished, he mentioned: “the whiff of stagflation is perhaps extra of a stench”.

Further reporting by Federica Cocco 

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