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Stagflation Risk Mounts in the Wake of Banking-System Anxiety

Isaac Nuriani    |
Apr 21, 2023
  • IMF says to expect weakest global growth in decades.
  • Economic downturn will be joined by persistent inflation, say experts.
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There’s little dispute that the turmoil we saw upsetting the financial system a month ago has subsided. But have we really seen the last of it? A number of expert observers, including former Treasury Secretary Larry Summers, have been saying it’s a little too soon to give the “all clear” on the turbulence that generated such a wave of anxiety among depositors and retirement savers.[1]

Fair enough. But let’s say, for the sake of discussion, that the crisis has been contained. Even if that’s the case, there now is serious talk that distress in the banking sector may prove to be the straw that ends up breaking the nation’s economic back.

For example, the release of the Federal Reserve’s most recent policy-meeting minutes reveal that central bank economists think the impact of the banking crisis will tip the nation over the recession cliff later this year.[2] The Conference Board feels the same way – but they think the recession will begin as soon as within the next few months.[3]

There are other concerns, as well, emerging about the near- to intermediate-term economic outlook – concerns that a broader, global slowdown in output is looming, one that could transcend a singular recession event in the U.S.

According to recent assessments by the International Monetary Fund (IMF), a number of influences will conspire to put significant downward pressure on economic growth through the foreseeable future. As a matter of fact, recent IMF projections say we could be facing the most sluggish multi-year period of global growth in more than three decades.

Intensifying the concerns about a protracted period of low output is the likelihood – in the view of numerous analysts – that inflation will remain a problem even as output is suffocated by higher interest rates and tighter credit conditions.

Anemic economic growth combined with higher (if not necessarily “high”) inflation raises the possibility that we could be looking at the return of the “s” word: stagflation. Morgan Stanley recently identified stagflation as the base case of their outlook, and BlackRock, the world’s largest asset manager, essentially did the same thing recently.

I want to shine some additional light on what the IMF, Morgan Stanley and BlackRock have said recently about the potentially problematic economic environment we could be facing. I think it’s important for retirement savers to recognize the following: Yes, the banking crisis could be over. However, a broad-based worldwide downturn could be next – one made even more difficult because of persistent inflation. And given the expectation that these conditions may last for years, such a downturn could prove to be a significant challenge to realizing the retirement security you and other Americans are working so hard to achieve.

There is some good news, however. It turns out there’s an asset that has established a track of record thriving in just the sort of stagflationary environments we’re pondering right now. And while there’s no way to know if that same asset will again surge against the backdrop of another “like” set of circumstances, it’s not inappropriate to recognize it has strengthened in those conditions before and to learn more about it – which we will do before closing out this week’s article.

As usual, we have a lot to talk about…so let’s get started.

IMF: We Expect Weakest Period of Global Growth Since 1990

The IMF turned a lot of heads with the release of its latest World Economic Outlook. That’s because the fund used that report to convey its most dismal expectations for global growth since 1990.

According to the IMF’s assessment, global growth will finish 2023 at 2.8% and remain at or around 3% for at least the next five years.[4] If that projection proves accurate, it would mean annual global growth will average 20% less than what it has averaged over the last two decades.[5]

The report made note of something I’ve been talking about for many months now: namely, that a variety of factors – including outright “global shocks” – are conspiring to create an exceptionally challenging environment for the world’s economic engine from here on out.

“The anemic outlook reflects the tight policy stances needed to bring down inflation, the fallout from the recent deterioration in financial conditions, the ongoing war in Ukraine, and growing geoeconomic fragmentation,” the IMF said.[6]

The IMF also says it’s assuming for now that financial-system disturbances have been contained. However, as so many others contend, the fund believes recent tumult has further darkened what already was a gloomy economic picture:

The major forces that affected the world in 2022 — central banks’ tight monetary stances to allay inflation, limited fiscal buffers to absorb shocks amid historically high debt levels, commodity price spikes and geoeconomic fragmentation with Russia’s war in Ukraine, and China’s economic reopening—seem likely to continue into 2023. But these forces are now overlaid by and interacting with new financial stability concerns.[7]

The environment the IMF is forecasting will feature more than “mere” economic downturn. It also is expected to be characterized by higher-for-longer inflation, as well.

“Global headline inflation is set to fall from 8.7 percent in 2022 to 7.0 percent in 2023 on the back of lower commodity prices, but underlying (core) inflation is likely to decline more slowly,” the IMF says. “Inflation’s return to target is unlikely before 2025 in most cases.”[8]

So, in the view of the IMF, significantly slower growth and chronically higher inflation – key ingredients of stagflation – could very well walk hand-in-hand in the years to come.

Except the folks at the IMF aren’t the only ones who think so. Recent analysis from Morgan Stanley also points to the possible onset of stagflation, as does the view from BlackRock.

Let’s look next at what they have to say.

Morgan Stanley: Stagflation Risks Are Mounting

Count Lisa Shalett, chief investment officer at Morgan Stanley, as another who is looking past the recent turmoil in the banking system to what that turmoil could mean for the “macro” economic landscape. And she’s advising savers to do the same.

“We think investors should think about the broader economic outlook,” she says, emphasizing that there are “mounting risks of a hard economic landing, weakening corporate profitability and ‘stagflation’ – when inflation remains high, the economy slows and unemployment rises.”[9]

Shalett sees three reasons, in particular, why recent banking distress has set the stage for an appearance by dreaded stagflation.

For starters, and like so many other analysts, Shalett expects the banking-industry upheaval to constrain overall credit availability. She goes as far as to suggest that tighter lending standards in the commercial and industrial sector could, by itself, translate into an increase in the unemployment rate “by 2.5 percentage points in the next one or two years.”[10]

The underlying fragility of the economy revealed by the banking crisis also suggests to Shalett that the Fed will have to end its battle against inflation before the fight is won.

“The risk,” says Shalett, “is that inflation stays higher for longer, even as the economy slows—a recipe for stagflation.”[11]

For its part, BlackRock has much the same perspective as Shalett. In an update to their 2023 global outlook, the asset-management giants reiterated their view that “the Fed’s fastest rate hiking campaign since the 1980s would cause economic damage and financial cracks,” adding – in a reference to the recent banking upset – that “those financial cracks have burst into view in recent weeks.”[12]

“We don’t see a repeat of 2008’s financial crisis,” BlackRock went on to say, “yet the bank tumult has reinforced our recessions view.”[13]

And while they don’t use the word “stagflation” explicitly, BlackRock analysts also see inflation coexisting with the projected economic downturn – key ingredients of the stagflation potion.

“The cycle of rapid rate hikes will stop without inflation being back on track to return fully to 2% targets, in our view,” BlackRock said recently in an analyst note. “We think we are going to be living with inflation…we see it persisting above policy targets in coming years.”[14]

The prospect of a stagflationary environment through the foreseeable future presents to retirement savers the risk that their 401(k)s and IRAs could be in store for a period of underwhelming performance. After all, it’s not much of a stretch to comprehend that weak economic growth has the very real potential to manifest as weakness in retirement-account productivity, as well.

In such an environment, savers will have to be a little more thoughtful in how they configure their holdings so as to optimize their accounts.

Fortunately, there is an asset that has managed to thrive in the contemplated environment: precious metals. In fact, according to separate analyses by both the World Gold Council and world’s-largest-hedge-fund Bridgewater Associates, gold, in particular, has distinguished itself as a preferred asset during periods of stagflation.

Let’s learn more about that now.

World Gold Council: Gold Is the Strongest Asset During Stagflation

It seems that gold and stagflation have cultivated a rather close relationship through the years.

According to analysis by the World Gold Council, a climate of stagflation “is the one that is most supportive for gold.” Along the same lines, the council notes that gold in U.S. dollars has been the single-best performer during periods of stagflation since 1973.[15]

“Should stagflation become widespread,” the council notes, “it could provide further support for gold as a diversifier and risk hedge.”[16]

Notably, the World Gold Council doesn’t rely on an overly strict interpretation of just what stagflation looks like to say that stagflation is, in fact, in play. As they put it, “rampant inflation” and “high unemployment” don’t have to be components of stagflation in order for the condition to exist. The council says that it also can appear as “a milder version, absent high unemployment but where household and corporate ‘margins’ are still squeezed by soaring costs and lower income.”[17]

Along with the IMF and Morgan Stanley, hedge fund kingpins Bridgewater Associates see stagflation as largely representative of the economic environment going forward. And just like the World Gold Council, Bridgewater resists defining stagflation in more generic terms – which is how they see it presenting this time around.

“We’re defining it broadly,” Rebecca Patterson, Bridgewater’s chief investment strategist, said last year. “We’re just saying slowing growth and higher than expected inflation.”[18]

According to both the World Gold Council and Bridgewater, the historical record seems to show that stagflation need not be characterized by dramatically high levels of inflation or unemployment to prove a hindrance to more traditional long-term savings paradigms or assets. Or to create an environment particularly fertile for precious metals.

Patterson notes that she and her team at Bridgewater researched economic scenarios and asset performance going back 100 years, and determined that gold was one of the best-performing assets, overall, during periods of stagflation.[19]

We certainly know that precious metals “shined” especially bright during what is perhaps the most notorious period of stagflation in U.S. history: the 1970s. During that decade, gold rose a remarkable 1,500% and silver surged an even more astonishing 2,000%.[20]

 

…….
[1] Chris Anstey, Bloomberg.com, “Summers Warns ‘Too Early’ for All-Clear on US Financial Turmoil” (March 31, 2023, accessed 4/20/23).
[2] Jeff Cox, CNBC.com, “Fed expects banking crisis to cause a recession this year, minutes show” (April 12, 2023, accessed 4/20/23).
[3] The Conference Board, “The Conference Board Economic Forecast for the US Economy” (April 12, 2023, accessed 4/20/23).
[4] International Monetary Fund, “World Economic Outlook: A Rocky Recovery” (April 2023, accessed 4/20/23).
[5] Jennifer Schonberger, Yahoo Finance, “IMF head warns world economy is set for weakest near-term growth since 1990” (April 6, 2023, accessed 4/20/23).
[6] International Monetary Fund, “World Economic Outlook.”
[7] Ibid.
[8] Ibid.
[9] Lisa Shalett, MorganStanley.com, “Why Investors Should Brace for ‘Stagflation’” (March 29, 2023, accessed 4/20/23).
[10] Ibid.
[11] Ibid.
[12] BlackRock.com, “2023 Global outlook Q2 update” (March 2023, accessed 4/20/23).
[13] Ibid.
[14] Phil Rosen, Business Insider, “The Fed won’t be able to bring inflation down to its target, and Americans will have to live with high prices for years, BlackRock says” (April 11, 2023, accessed 4/20/23).
[15] Johan Palmberg and Krishna Gopal, World Gold Council, “Stagflation Strikes Back” (March 25, 2022, accessed 4/20/23).
[16] Ibid.
[17] Ibid.
[18] Jennifer Ablan, Pensions & Investments, “Bridgewater’s Rebecca Patterson: Fed risks credibility in inflation fight” (August 25, 2022, accessed 4/20/23).
[19] Ibid.
[20] StockCharts.com, “Gold, Silver – Continuous Contract, 01/02/70 to 01/02/80” (accessed 4/20/23).

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