While most of us are familiar with the term inflation, stagflation is less commonly known but presents risks to the global economy and markets. In short, stagflation is a period of increasing inflation coupled with slow or stagnant economic growth.

As we work our way through the pandemic, plenty of unanswered questions remain. The biggest are the impacts of the $20+ trillion of monetary stimulus and how the global economy will function once it’s removed.

Truth be told, we are still in the middle innings of this phase, but we should gain clarity in the coming months. While central banks have finally pledged to reduce stimulus and increase interest rates, they have said this many times and then pushed further out than expected. Whether this time is different remains to be seen.

Part of what’s driving central banks to act has been the steady rise in inflation. The Federal Reserve assumed the increase was transitory and would subside after a few months. Unfortunately, their assessment has been incorrect so far, and many anticipate higher inflation through year-end.

It is important to acknowledge just how accommodative central banks have been since the Great Financial Crisis. Markets have come to expect central-bank intervention through interest rate cuts and additional rounds of quantitative easing (QE) at every turn.

This policy moved into high gear once the pandemic unfolded. Central bank balance sheets have expanded by ~600% since 2008 and ~50% alone since 2019.

Central banks have spent ~$834 million an hour in just bond purchases for the past 18 months! This spending helps partially explain why both equity and bond markets continue to set record highs.

The good news is inflation has been nonexistent for the past decade. The question we face today is what happens if inflation persists while central banks attempt to taper? This is where the potential for stagflation enters.

Stagflation typically arises when the following occurs:

Increasing inflation
Elevated unemployment rate
Slow economic growth

Currently, two factors are present: increasing inflation and elevated unemployment. Whether these are transitory depends mainly on the pandemic and how much of the stimulus punchbowl is removed.

INFLATION

From April through July 2021, the year-over-year increase in inflation was the highest on record since 2008! While worrisome, it is important to note that inflation was nearly 0% from April through July of 2020.

While an increase had been expected, the concern is with the amount of inflation and its persistence. The Federal Reserve insists that inflation is transitory, but what if it continues to increase?

Inflation is being tracked closely because if it persists, markets are likely to get extremely volatile. And central banks can do little in that situation.

UNEMPLOYMENT

While the unemployment rate is hovering at ~5.5% and hasn’t budged much over the past few months, it is down ~65% from the highs in 2020.

In normal conditions, an unemployment rate this high is alarming, but it also seems a bit deceiving as there doesn’t seem to be a shortage in job openings. In fact, in July, more than 9 million jobs openings were posted, the highest level recorded.

The pandemic has changed the way people work. With many people relocating and pursuing a job with more remote flexibility, it could take some time before things work themselves out. In addition, with many states providing extended unemployment benefits, workers have more time to wait for the job opening that matches their exact criteria.

While we can’t discount the possibility that the recent spike in COVID has led to a slowdown in consumer spending, which would hurt hiring, it is too soon to draw any conclusions.

As with inflation, central banks have little control over unemployment and can’t force employers to hire. Their only option would be to backtrack on their plans and increase stimulus spending, which could fuel a larger spike in inflation and compound the problem even further.

ECONOMIC GROWTH

This is one area that has excelled and hasn’t shown significant signs of slowing. We have now experienced three consecutive quarters of increased gross domestic product (GDP) growth.

While positive, we must remember that for much of the spring and summer, COVID cases were declining. The road to recovery had looked promising until the Delta variant took hold. The variant led to a surge in cases and hospitalizations, which could pour cold water on some of the recent progress we’ve made.

To be clear, we are not in a stagflationary period, and many variables remain at play. However, if inflation persists while central banks attempt to reduce stimulus and COVID continues to spread, then stagflation will become a real possibility. Until then, we should continue to monitor the data and not be quick to draw any conclusions.

Discuss your situation with a fee-only financial advisor.

The commentary on this website reflects the personal opinions, viewpoints and analyses of the Divergent Planning, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Divergent Planning, LLC or performance returns of any Divergent Planning, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Divergent Planning, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Divergent Planning, LLC provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. Divergent Planning, LLC is not responsible for errors or omissions in the material on third party websites, and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.

Divergent Planning, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Divergent Planning, LLC and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Divergent Planning, LLC unless a client service agreement is in place.

General Notice to Users: While we appreciate your comments and feedback, please be aware that any form of testimony from current or past clients about their experience with our firm on our website or social media platforms is strictly forbidden under current securities laws.