Relax: It’s not Stagflation…Yet

Alphabet (GOOGL) and Microsoft (MSFT) have had impressive earnings announcements, which boosted the equity futures markets significantly. However, we cannot overlook the significant issue at hand: the GDP data and the inflationary pressures that have reemerged over the past several months. Yesterday's GDP figure was unexpectedly low, sparking speculation about the U.S. potentially entering a stagflation environment. Let’s look at what stagflation means.

Stagflation is a scenario in which an economy experiences slower growth while inflation continues to rise or remains at elevated levels. A key factor that divides economists and economic pundits is the labor market component. Some argue that stagflation involves slowing economic growth (using GDP as the metric) combined with rising inflationary measures such as the Consumer Price Index (CPI) or the Personal Consumption Expenditures (PCE). Others add labor market deterioration along with the other broad-based guides to define stagflation. This is why some analysts are starting to discuss the stagflation narrative. However, any declaration of stagflation at this point, with such limited data and duration, is premature.

The Advance GDP estimate was significantly lower than market expectations, but this figure will be revised twice over the next two months, so adjustments to the preliminary number should be anticipated. The notes that the Advance GDP print includes incomplete data or data subject to revisions. According to the Bureau of Economic Analysis which publishes the GDP dataset, the average revision between the Advance GDP data and the first revision is 0.5%. For perspective, yesterday’s figure could be significantly adjusted either upward or downward. Furthermore, the average adjustment between the first revision (secondary) print and the final GDP print is 0.3%. These revisions occur over two months, making it far too early to determine stagflation. Similarly, it would be prudent to wait for two finalized GDP prints before using this metric to declare stagflation, which will take five to six months, and much can change in that time, especially regarding inflation, the second critical component for the stagflation narrative.

The Price Index within the GDP print is stale. We have already observed inflationary pressures on the horizon, with CPI and Producer Price Index (PPI) providing clear indications that 1Q’s PCE metric would come in hotter than the previous quarter. The monthly inflationary measures are more influential on Federal Reserve members than the GDP Price Index due to their frequency and responsiveness to input prices.

Is stagflation a possibility? Certainly, anything is possible. However, commodity base effects will likely be favorable for the Fed during the late summer months for a brief period, which may provide some breathing room. Any relief from the reflationary narrative, even temporarily, may reset the timeline for declaring stagflation, pushing the appropriate time to declare deflation into early next year.

Stagflation is not a favorable environment by any means and is a rare occurrence in the United States, highlighted by the unique economic dynamics experienced between the mid-to-late 1970s and the Federal Reserve's missteps in the early 1980s. We are not close to that scenario at the moment. Inflation is a near-term concern, but if the labor market begins to deteriorate, we may face a more significant problem. Something to keep your eye on.

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