Stagflation - A Word You Will Hear a Lot.

Stagflation - A term referring to high inflation happening simultaneously with stagnating economic growth or outright recession.

Imagine living in a community where the effects of a slowing economy are beginning to take hold, such as increased layoffs, reduced discretionary spending, and a general sense of unease. But at the same time, you notice that prices for food, clothing, and essential needs are rising. We have all heard the economic slogan, “Supply and demand are correlated,” and lower demand (spending) should bring about lower prices. But today we inch closer to the very conditions that are defined as Stagflation - the economy is slowing down, but costs for goods and services are rising.  

The current issue involving tariffs and arbitrary actions to penalize industries or specific companies has created a massive cloud of uncertainty that hangs over our nation’s economy. The Federal Reserve is confronted with difficult decisions that stem not from the regular ups and downs of the business cycle, but from non-market forces that are slowly eroding the “free-market” approach to our capital markets.

Stock prices are based on future expected earnings. Suppose the calculation of expected earnings cannot rely on traditional inputs. In that case, additional factors can create volatility levels that a growing number of retirees should not be exposed to in this stage of their lives.

 Below are options the Federal Reserve (Fed) could employ to help manage the economy’s well-being in the next few crucial months.

 
Lowering Interest Rates?

The traditional remedy the Fed uses to stimulate the economy is increasing the country’s money supply, which enables companies to hire more employees, increase consumer spending, and foster consumer confidence. The Federal Reserve can lower interest rates, buy government bonds (easing the money supply), or reduce the amount of cash reserves that banks need to hold, all of which are monetary policy measures that can increase the money supply.

Lowering rates would likely have the most significant impact on the housing industry, which could propel the economy to stronger growth and maintain low unemployment. Due to the multiplier effect, a surge in home buying (with abundant supply now) could positively impact numerous industries involved in the construction of new homes, as well as furnishing and remodeling existing homes.

The issue is that lowering rates during a period of tariff-induced higher prices may not lead to increased spending or growth, as higher prices for construction and consumer goods will only decline if tariffs and other sanctions are drastically reduced or eliminated.  

Raising Rates?

Raising rates is one of the primary strategies of the Fed’s monetary policy arsenal. The Fed will employ measures to cool down a “hot economy” by reducing or tightening the country’s money supply. However, a “hot economy” generally indicates more hiring, increased spending, higher production, and ultimately, the argument goes, higher prices. However, none of these factors are currently moving in a positive direction, except for prices; due to the constant uncertainty, most indicators are projected to worsen. It is unlikely that the Fed will raise rates in our current environment.  

Do Nothing and Wait…..

 I believe the Fed's mindset at this point is to do nothing and wait. Any Fed actions that are meant to be at least partially considered long-term could be upended by a sudden social media tweet or statement. A quick resolution would be ideal, of course, but a prolonged “on and off” scenario will slowly weaken the foundation of the global markets. 

Different conditions describe price movements.

Inflation – Prices rising from one period to another.

Deflation – Prices decrease from one period to another.

Disinflation – Prices are increasing, but at a slower rate.

 Stagflation – Prices rise while the economy is in a recession.

It appears that “risk tolerance” may need redefining for investors investing in the capital markets. Hiring a source of trusted financial advice can help you navigate the uncertain future with experience, knowledge, and fiduciary care. I have provided financial advice to clients for over twenty-five years. Please call us at (925) 484-1671 or contact us to schedule a no-cost consultation.