1970’s Stagflation Inbound for the US or Just a Hard Landing?

The latest ignition of the Middle Eastern conflict is aligned with more than one historical parallel. Fifty years ago, on October 6, 1973, the Fourth Arab-Israeli War began, also known as the Yom Kippur War. In macroeconomics, that 1970s period introduced a novel concept dubbed stagflation.

Observed for the first time in modern economic theory, stagflation was marked by a combination of high prices, slow economic growth, and high unemployment. Through the lens of conventional economic models, this is highly unusual because both unemployment and a slow economy reduce demand for goods and services, lowering inflation instead.

It is widely believed that the 1970s stagflation anomaly sparked due to the oil shock supply of 1973. Namely, the Yom Kippur War led to an oil embargo pushed by the Organization of Arab Petroleum Exporting Countries (OAPEC). As oil prices sharply jumped, the US inflation rate followed at 11.1% the next year. 

This was the highest inflation level in the US since the end of World War II. This week, Deutsche Bank analysts revisited this parallel. Could we see a repeat of history on a global scale?

Deutsche Bank’s Stagflation Concerns Against the Conference Board Data

Economist Henry Allen, working as a strategist at Deutsche Bank Research in London, is a regular speaker at mainstream financial events, from Financial Times and Bloomberg to The Wall Street Journal. His most recent contribution with other DB analysts draws parallels between the current global landscape and the one in the 1970s.

Following the oil supply shock in 1974, the US GDP growth was negative, at -0.54%. Likewise, the global inflation averaged at 11.3%. We are presently outside the negative territory but nearing it. According to the Conference Board’s forecast, the real GDP will fall to 0.8% in 2024.

The Conference Board is a non-profit research organization widely used by governments and businesses. In the same forecast, CB stated that we are “far from it” regarding taming inflation specifically, that the Fed’s 2% inflation target will not be reached until the end of 2024.

Regarding unemployment, CB projects a 4.2% peak rate by Q3 2024. 

Strong El Niño to Exacerbate Food Prices?

What CB doesn’t explicitly take into account DB analysts do. Namely, the potential fallout from an El Niño event. Previously, this climate pattern caused droughts and floods in certain regions, triggering higher food prices.

Henry Allen apparently drew this signal from NOAA’s Climate Prediction Center. As of the September 14th forecast, there is a greater than 95% chance through January – March 2024 for a “strong” El Niño. The caveat is that this “does not necessarily equate to strong impacts locally.”

However, such an event could exacerbate the existing global food crisis. The International Monetary Fund (IMF) is also calling it “far from over” as it “strongly” affects 45 countries. Expectedly, the most affected region is in the Middle East and Central Asia (MCD).

Fragile US Banking Sector Favors Recession Instead of Stagflation?

As supply shocks go, crude oil is the domino that could set all other costs in motion. This would then translate into a fertile ground for the anomalous stagflation combo – high inflation, high unemployment, slow growth. Of the G7 nations, the UK, Italy, and Germany are leading the pack in high inflation. This is despite the Eurozone falling into a technical recession in June 2023 following the boomeranged sanctions against Russia. 

At the same time, DB analysts note that persistent wage increases do not alleviate inflationary pressure. As of the latest report by the US Labor Department, the jobs market remains strong, with nonfarm payrolls having increased by 336,000 in September. 

Yet, monthly wage growth remains roughly the same, rising 0.2%. Year-over-year, wages increased 4.2% in September, just slightly lower than 4.3% in August. This suggests the cooling of wage inflation.

Depending on the conflagration level of the Middle Eastern conflict, the macro landscape has some potential for stagflation. Nonetheless, the Federal Reserve is the significant actor here, as the central bank may trigger a recession with more rate hikes or if the existing level stays for longer.

After all, Fed Chair Jerome Powell has repeatedly said that the labor market needs to “loosen.” This may materialize from the US banking system as the starting domino. Excluding the 100 largest banks by asset size, regional banks are seeing the highest credit card loan delinquency rates in decades.

In other words, this could be the Federal Reserve’s “when something breaks” moment. In that scenario, the more volatile geopolitical situation would serve as a solid framework to sweep the hard landing under the rug.

Do you think recession is preferable to stagflation? Let us know in the comments below.

About the author

Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird’s US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.