Mid-Summer Stagflation Update

This is a transcript of a brief webinar that we have posted on stagflation risks.

As a reminder we have been recommending that a neat way to keep tabs on those risks would be to look at the spread between global growth surprises and global inflation surprises. If that spread has been in negative territory for some time it would suggest that growth expectations have been ebbing or that inflation expectations have climbing and possibly both and with attendant increased risk of a stagflation combination

So where are we now? As the charts in figures 1 and 2 below suggest we have seen a higher risk of a global stagflation scenario emerge of late insofar as our indicator as plunged into deeper negative territory in the past few weeks. And that in turn can mostly be traced to a steady drumbeat of downbeat news on the global growth front.

Figure 1: An updated stagflation stress indicator

Figure 2: Zooming in on our stagflation stress indicator

In fact, incoming data for inflation have been a little better-behaved. As figures 3 below suggests that may in part be because some of the heat has been coming out of commodity prices.

Figure 3: Many commodity prices have rolled over in recent weeks

And that in turn can partly be traced to weaker than expected demand as evidenced in the data figure 4. That figure suggests that commodity prices have shifted in harmony with economic data surprises in recent years. Given the heavy preponderance, however, of data on manufacturing activity in the make-up of these surprise indicators what the chart also hints at is that demand for manufacturing goods and by extension commodities has also been ebbing quite sharply.

Figure 4: The weakness of commodity prices chimes with the weakness of incoming global growth data

And that chimes too with the messaging from recent manufacturing-surveys suggesting that demand cooled off very sharply last month and that as it has done so supply chain bottlenecks have eased as well.

In figure 5 below we can see the evidence for that in the average spread between the new orders balances and the supplier delivery times balances in PMI surveys, which has plunged in recent months. As the chart further suggests this could imply even more downside for commodity prices in the period immediately ahead.

Figure 5: Evidence of weaker demand and firming supply suggest more downside for commodity prices

Further evidence incidentally that suggests a growing imbalance between demand and supply has emerged from the hefty contributions from inventory swings that featured in many economies in their Q1 GDP reports. The Euro Area, Japan, the UK and to a slightly lesser extent the US have seen a great deal of inventory accumulation over the last 2 to 3 quarters. This may hamper production activity and further impinge on economic growth and inflation outcomes in the period ahead. In other words the inflation side of the stagflation equation may continue to be less threatening.

Figure 6: A hefty pace of inventory accumulation in major economies in Q1

But while all this could, in turn, herald a turn in the inflation cycle this is not necessarily positive news for growth optimists. And that's because central banks are now responding much more forcefully to high levels of inflation. Many major central banks and the US Fed, ECB and Bank of England in particular are raising interest rates more aggressively than many imagined a few months ago. And that's lifted expectations for how far interest rates will climb - and shifted bond yields up at the same time. On the data front we can see this shift more clearly in the degree to which US Treasury yields appear to have detached themselves from the incoming global growth data in recent weeks.

Figure 7: Still-firm US Treasury yields conflict with weak global growth data

What's the bottom line? Stagflation risks have been rising according to our simple spread index but that doesn't tell the whole story. The key story is that alarm bells are now ringing much more loudly about global recession risks and the policy errors that could follow not least if central banks pay too much attention to lagging inflation indicators and insufficient attention to growth.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.