You’ve likely been seeing the word Stagflation pop up across your TV, computer screen or phone but what does it really mean in regards to inflation, growth and employment? First let’s define it – Stagflation is where an economy is experiencing a simultaneous increase in inflation and a stagnation of economic output. In simple terms, it is high inflation coupled with an increase in unemployment and slowing growth. While we can look back and better understand periods of rising and falling growth and employment we do not have as much empirical data regarding inflation. With inflation being the key ingredient to Stagflation – lets start there.
Inflation: To understand how we got to where we are at today, let’s take a quick look at where we’ve been. The U.S. has not really had to worry about inflation since the late 70’s early 80’s when the infamous Paul Volcker raised the Federal Funds rate to nearly 20% killing both inflation and the economy. Since then, the Federal Reserve (Fed) has been using Monetary Policy to lower interest rates in order to spur growth by reducing the cost of capital (see Federal Funds Rate chart below).
Now they have only been able to do so because inflation has never really flared up long enough to meaningfully change their outlook. This, along with technology advancements, have been a massive tailwind for innovation and has led to both increased productivity and decreased cost of goods/services. As one would imagine, this has been putting downward pressure on inflation resulting in our economy seeing disinflation for quite some time. We can see it firsthand with companies such as Amazon and Tesla, who were able to take advantage of the ability to borrow cheap and run their businesses unprofitably for decades in order to hit critical mass. We as customers are now the beneficiary of this. With the click of a button, we can have a package arrive on our doorstep in 24 hours instead of driving to the local store and picking it up. What would have previously cost us additional time, energy and money now can be consumed at a fraction of the price. That is quite disinflationary!
It appeared this disinflationary theme was well entrenched until Covid came along. Once the government gave us the green light to re-open the economy we were hit with a massive supply / demand imbalance. This instantly led to more dollars chasing fewer goods kickstarting inflation. Continued friction with supply chains along with fiscal stimulus on the demand side only exacerbated the inflationary pressures. Throw in an abhorrent invasion of Ukraine creating a surge in energy and food prices and that has led us to where we are at today, 8.6% YoY inflation. This high inflation number has set the stage for Stagflation.
Growth: Now that inflation has reared it’s ugly head for the first time in a long time the Fed has had to react. Unfortunately, they only have one blunt tool to address the situation and that is raising rates to slow growth. They began this process early this year and it appears to be working. Whether it was their actions or the economy naturally cooling off we are on track for our second quarter of negative growth (nearing a technical recession).
Unemployment: We now know we have high inflation and slowing growth but what about the last piece of the puzzle, rising unemployment? Finally some good news! Currently, our economy’s employment situation is fantastic. Not only do we have a historically low unemployment rate but we have more job openings available now than we ever had in the past. While we currently have a healthy labor market things can change quickly. We have already begun to see hiring freezes, layoffs and CEO’s with less optimistic views into the second half of 2022 so we may be on the brink of this turning the other way.
Conclusion: Without rising unemployment, we narrowly dodge being in a Stagflationary environment. And while it ultimately is just a label for economic stagnation it encompasses three important areas all active investors are watching and reacting to. Ideally in the following months, we begin to see inflation decelerating, growth turning positive and our labor market continuing to stay strong. That being said, it will take some time to see this play out in the data, and in the meantime we will be watching more high-frequency data and listening to our portfolio companies give their outlooks in the upcoming earnings season to help guide our positioning.