Strategic Briefing | 3.18.2011 | Stagflation Risk

Supply Disruptions Pose Threat of Stagflation
The Wall Street Journal | Mar 17
A scramble for supplies prompted by Japan’s crisis may add to the specter of stagflation stalking the U.S. economy. Already, high oil prices and geopolitical uncertainty have taken some of the buzz out of 2011 growth prospects. The first quarter in particular looks like it will end on a much weaker note than initially thought. Morgan Stanley’s tracking estimate of annualized real gross-domestic-product growth has dropped from 4.5% to 2.9% over the past six weeks. A similar one from tracking firm Macroeconomic Advisers has slipped to 2.5%.

The Economic Consequences of the Arab Revolt
Nouriel Roubini (Project Syndicate) | Mar 14
Political turmoil in the Middle East has powerful economic and financial implications, particularly as it increases the risk of stagflation, a lethal combination of slowing growth and sharply rising inflation. Indeed, should stagflation emerge, there is a serious risk of a double-dip recession for a global economy that has barely emerged from its worst crisis in decades. Severe unrest in the Middle East has historically been a source of oil-price spikes, which in turn have triggered three of the last five global recessions. The Yom Kippur War in 1973 caused a sharp increase in oil prices, leading to the global stagflation of 1974-1975. The Iranian revolution in 1979 led to a similar stagflationary increase in oil prices, which culminated in the recession of 1980-1981. And Iraq’s invasion of Kuwait in August 1990 led to a spike in oil prices at a time when a US banking crisis was already tipping America into recession.
BofA Merrill Lynch Fund Manager Survey Reveals Growth and Profitability Fears After Oil Price Spike
Bank of America | Mar 15
Following the recent oil price spike, investors fear for corporate profitability and global growth, according to the BofA Merrill Lynch Survey of Fund Managers for March. A net 24 percent of asset allocators now expect corporate operating margins to fall over the next 12 months. This represents the sharpest month-on-month decline since the survey began asking this question in 2004. As recently as January, a net 10 percent was expecting margins to expand. A net 32 percent of fund managers still look for corporates to increase profits in the next year, but this is down significantly from a net 51 percent a month ago. A net 31 percent now views consensus earnings estimates as too high, moreover. This decline in confidence is reflected in the survey participants’ macroeconomic outlook. A net 31 percent of fund managers still believe the global economy will strengthen in the next year, but this is down from a net 51 percent last month. In the U.S. the fall was even sharper, from a net 52 percent to a net 21 percent, while respondents in Asia outside Japan turned negative. A net 25 percent sees the region’s economy weakening over the period. While fears of recession remain remote, the threat of stagflation has risen, according to the survey findings. In the space of two months, the proportion of fund managers anticipating below-trend growth and above-trend inflation has doubled to 38 percent. Among four possible outlooks, this is now the most common among respondents.
Stagflation, 70s icon, dusts off disco shoes
Reuters | Mar 11
“I hate to mention the word stagflation, but that seems to be what fears are out there at the moment,” said Martin Hegarty, who co-heads the management of about $22 billion in global inflation-linked portfolios for BlackRock, the world’s largest asset manager. Hegarty sees inflation concerns as contained for now, though the rise in oil is threatening momentum in the economic recovery at the same time as a number of other economic headwinds are threatening the rosy outlook.
PPI: Mixed Results in February
Wells Fargo Economics Group | Mar 16
The good news for the Federal Reserve is that the producer price index for finished goods increased by 1.6 percent due to strong increases in food and energy prices, while the core index only increased by 0.2 percent, a slowdown compared to the 0.5 percent increase during the first month of the year. Prices for finished energy goods increased by 3.3 percent during the month, while prices for finished consumer foods increased by 3.9 percent. According to the report, the 3.9 percent spike in finished consumer foods was the largest monthly increase since November of 1974, when it posted a rate of 4.2 percent. This comparison should not be taken lightly. The comparison to 1974 is very telling because that was the year when the “stagflation” period started. Recall that stagflation is defined as a combination of economic stagnation and inflation. Having said this, it is still too early to try to make more analogies to the 1970s even though there are several characteristics that are very similar. While in 1974 the world was shocked by the first oil embargo, today’s situation is void of an oil embargo but the same region of the world that declared the oil embargo is going through very difficult times and the end outcome could have similar effects on the petroleum market that the oil embargo had in 1974. Of
course, this is only if the situation in the Middle East and North Africa continues to deteriorate and the crisis continues to spread to Saudi Arabia and other oil producing countries. Thus, this is the worst possible scenario, which, today, is not our base case, with our forecast of 2.7 percent GDP growth for 2011.
Fed Needs Better Barometer to Detect Inflation
Alliance Bernstein | Mar 4
According to the Fed, a sustained rise in US inflation is unlikely while the economy has substantial idle capacity. We think the Fed’s output gap framework relies too much on domestic conditions, and overlooks important changing dynamics in the global economy that may eventually create new inflationary pressures… The Fed’s view on inflation is rooted in an output gap framework, which argues thata sustained rise in inflation is unlikely to develop as long as underutilized resources and idle capacity exist in the economy. It’s always been difficult to reliably estimate an output gap that effectively translates slack in the economy into actual price trends. These days, it’s perhaps even more difficult to do so, as the main drivers of US economic growth are changing and emerging markets are playing a more dominant role in the global growth cycle.
Stagflation will have more bark than bite
CityWire | Mar 16
It seems that we are never happier in the investment community these days than when we have something new to worry about. Indeed, two numbers caught the attention of the media in January – inflation and growth. The former was high and the latter was low. Speculation soon started as to whether the UK was returning to days of old and a period of stagflation. I think that assumption is highly premature. The current cycle will have plenty of issues, but stagflation is unlikely to be one of them. To understand why, we should separate the two elements of the equation, stagnation and inflation, and analyse them separately. Consumer price inflation was reported at an annual rate in December of 3.7%, well above the Bank of England target of 2%. Price increases were fairly broad, but not even. Oil and oil-related goods and services were especially strong. Overall inflation has been exacerbated recently by a fall in sterling, the general rise in commodity costs and the new year rise in VAT. The numbers are not comfortable, but they are a very long way from the double-digit inflation recorded in the 1970s. It is possible that some of these influences – particularly rising commodity costs – might persist for some time. It is also fair to suggest that some of the favourable deflationary dynamics of recent years – notably the emergence of China as a source of low cost goods – are coming to an end.
China’s stagflation
JP Morgan | Mar 14
Last week’s data releases suggested that the Chinese economy may be undergoing a mild dose of stagflation. The manufacturing purchasing managers’ index eased back from 54.5 to 51.7, well off the January 2010 peak of 57.4 though still signalling expansion. The services equivalent tells a similar story. Export growth slowed markedly, from 38% to 2% y/y contributing to a trade deficit of USD 7.3bn. However, comparisons are rendered meaningless by the timing of Chinese New Year, although the trend of the trade data suggests that activity may be slowing significantly. Nevertheless, it will probably take until the end of Q2 to confirm this impression. Consumer prices rose 4.9% y/y, unchanged from January with food prices once more proving to be the driver of inflation. This week will be interesting to gauge if monetary growth is still powering ahead, or whether the People’s Bank of China’s efforts to slow the economy are bearing fruit. It does look as if China may be experiencing a combination of slowing activity and sticky inflation. In particular, further measures may be needed for the Chinese authorities to address a sizeable monetary overhang.
Investment Comment – March 2011
Melville Jessup Weaver | Mar 14
The Japanese earthquake is expected to dent the outlook for oil usage which will counteract the continuing political upheaval in the Middle East which had put upward pressure on oil prices. Coupled with already rising prices for other commodities and food, this had led to the spectre of stagflation (rising prices in a stagnant growth environment). US and Euro-area industrial production indexes both declined in late 2010 and early 2011, Euro-area GDP grew just 0.3% in the 3 months to December 2010. However inflation is still running above targets in several markets – most notably in the UK where the January CPI release was 4.0% for the year, twice the Bank of England’s target. Despite the sluggish growth in the West, the developing world continues to expand strongly. China’s economy grew 9.8% over the 2010 year and inflation is running at 4.9% (above the official target of 4%). Indeed, China’s central bank raised interest rates by 0.25% for the 3rd time in 4 months in an attempt to cool its economy. China has officially passed Japan to become the world’s second biggest economy. Japan’s GDP was US$5.5 trillion in 2010 whereas China’s was US$5.9 trillion. However the Chinese story is not all good news. Prices there are rising sharply and this will impact on the prices in New Zealand on Chinese imports. There are further the real problems posed by a working population unhappy at not sharing in the growing wealth of the upper strata of communist China; this has led to stories about a possible Jasmine Revolution following on from events in the Middle East.