Stagflation, Should We Be Concerned?

Definition of Stagflation:

Recent economic metrics show some concern we could be nearing a period similar to that of the 1970s. Both the CPI and PPI, Finished Goods less Food & Energy, ran up into 1974. The Unemployment rate, and EHUPUS Index followed and the QoQ GDP went negative for 3 quarters in a row, meeting the above definition.

There was a period of recovery, when CPI and PPI were both reduced by at least 50%, while unemployment pulled back from a rate of 8.87% to 5.7%, and there were 20 straight quarters of positive QoQ GDP.

Then Inflation reared its ugly head again and both CPI and PPI doubled, Unemployment almost doubled rising from 5.75 to 10.67%, and there were 2 instances of QoQ GDP being negative for 2 consecutive quarters.

Now, the unanswerable question is this: was the pandemic a one-off event or are we setting up for a similar pattern to be repeated?

When looking at the more recent CPI and PPI readings, its evident that there is subtle, but undeniable, upward trend.

CPI

PPI

Unemployment

Is there any evidence that unemployment is on the verge of turning higher, other than the thesis we are headed into a period of stagflation?

According to the St. Louis Fed, FRED, Temporary Help Services has peaked and begun to head lower.

Other employment metrics:

ISM Manufacturing Report on Business Employment

Job Openings

This last employment chart is exceptionally relevant considering the recent intentions of Elon and Vivek under the new administration.

As for “stagnant economic growth”, the Atlanta Fed has a different view: 2.5% is healthy and a long way from negative.

So, what should we be monitoring to help anticipate the possibility of Stagflation?

We thought taking a deeper look at those Inflation metrics, and what is really driving them. Is it different than the 1970s episode?

Of the 2.6% present CPI #, 2.86 of that Is Core Services, and of that #, Shelter is 1.74 and Transportation Services is .51.

As seen above, both have been moving steadily lower, but just recently had small upticks.

In the case of PPI, Services represent .179 of the .197 total number, or 91% . Finished Services less Trade Transportation and Warehousing represent more than 50% of the Gross number at .122.

Why get into the weeds here? Both inflation metrics have been on the glide path the Fed has been attempting to navigate since they began raising rates. Why can’t the market just shake the recent small upticks off as “noisy” numbers?

This is why:

Since the Fed began reducing rates in September, by 75bps, the yield on the 10yr TSY has increased 85bps. This is not exactly what the intended outcome was. So, Investors are asking questions, which brings us back to the weeds of what exactly is driving the very subtle uptick in the 2-inflation metrics.

With respect to the PPI for services less trade, transportation, and warehousing, the following are included: telecommunication services, medical care, insurance, and lodging.

When we see charts like the one below, its not hard to understand why the PPI is doing what it’s doing. The medical care inflation chart was simply too depressing to include as most of know all-too-well, already.

So, we narrowly focus on Shelter and Services contributions to the CPI and PPI to see if the subtle uptick turns into something more. But let’s not forget about the other side of the equation, unemployment. The November jobs number will be even more highly anticipated than usual. October was the weakest number since December of 2020.

December 6th the NFP will be released and should provide clarity on whether the recent 12k number was a fluke or the beginning of something few market participants would like to see: potential stagflation.

Have a great weekend!

Best

Meraki Trading Team

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