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Stagflation risk low even as energy prices rise, economic pressures mount

A growing pile of troubling economic signs is evoking fears of a possible return to a 1970s-style U.S. economy, though analysts and economists say it is unlikely the country's recovery will drift that far off course.

Millions of people remain out of work, inflation has yet to peak, energy prices are skyrocketing, a global supply bottleneck has shown no hint of easing and the Federal Reserve has signaled that the end of ultra-loose monetary policy may be near. That is causing concerns that the country will fall into stagflation, a period marked by high inflation and stagnant economic growth, though experts do not expect history to repeat.

"Stagflation talk is overhyped, with a 1970s type of misery unlikely in our view," said Oren Klachkin, lead economist at Oxford Economics.

Continued GDP growth and the slowly improving jobs picture make a return of the past unlikely, Klachkin and others said. Pressures that persist longer than projected or an unexpected downturn could trigger further economic pain, though expectations are still pointing to an eventual recovery.

Looking back

The term stagflation, or recession-inflation, was introduced in the 1970s when joblessness and inflation spiked and growth idled. The crisis was rooted in the OPEC oil embargo and resulting energy crunch.

Fears of a return to those conditions have emerged in recent days amid a jump in energy prices and other signs that the pandemic recovery could be in trouble.

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Benchmark NYMEX crude oil futures settled just below $79 per barrel on Oct. 5, its highest price since 2014, after OPEC and its allies agreed to boost production in November below expected demand levels. U.S. gasoline prices are the highest they have been in six years, reaching $3.24 per gallon on Oct. 7, up from $2.18 per gallon a year ago, according to AAA. U.S. natural gas prices this week also topped their highest levels since 2008.

Meanwhile, inflation remains high and unemployment has yet to recover to pre-pandemic levels. The core personal expenditure index, which strips food and energy prices from broader inflation measures, rose 3.6% in August, according to the latest government data. The unemployment rate in August was 5.2%, much higher than the pre-pandemic 3.5%.

"The stagflation argument continues to grow," said Andrew Brenner, head of international fixed income at National Alliance Capital Markets.

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Markets are also reflecting waning investor confidence in the economy, with the S&P 500 down about 4% from early September to Oct. 5.

The U.S. Treasury 10-year yield, which moves opposite to the bond's price, rose from 1.31% on Sept. 1 to 1.54% on Oct. 5, largely due to indications that the Fed will soon start tapering its $120 billion in monthly securities purchases.

"I don't think we are there yet but we could be heading to a period — and some sort — of stagflation, if the current trends don't change," said Fawad Razaqzada, a market analyst with online brokerage ThinkMarkets.

Moving ahead

Yet, many of these circumstances are likely to be temporary. The emergence of the delta variant did slow the economic recovery in the third quarter, while infection rates and fears of COVID-19 seem to have peaked, said Klachkin of Oxford Economics. This will "reaccelerate" economic growth and job growth in the fourth quarter, Klachkin said.

Inflation will continue to run at a hotter rate than it was prior to the pandemic, Klachkin said. Still, supply-side pressures, including low inventories, transportation logjams, high input costs and labor shortages, will all likely normalize in 2022, Klachkin said.

GDP growth also hit its highest level in 70 years in the second quarter, with the seasonally adjusted annualized figure rising 16.8% year over year. Even though unemployment is higher than it was before the pandemic, the rate is roughly in line with where it has been over the last 100 years, said Matthew Weller, global head of research at FOREX.com and City Index.

All of that means calls for a return to stagflation are premature, Weller said.

"Traders worried about stagflation should keep a close eye on the outlook for economic growth," Weller said in an interview. "With many forecasters projecting solid growth in the 5% range for both the US and world as a whole next year, it would take another massive unexpected economic dislocation to tilt the odds toward stagflation."

GDP is expanding, although at a slower pace than many economists initially forecast. While elevated, the U.S. employment rate is at the lowest point since March 2020 and is expected to keep falling.

"This picture doesn't match with the one of the stagflation we had in the '70s where GDP was contracting and unemployment was almost double where it is today," said Althea Spinozzi, a senior fixed-income strategist at Saxo Bank.

Lingering cause for concern

Still, Spinozzi said that if supply chain bottlenecks and high energy prices persist, consumer spending and unemployment could take a substantial hit.

Skyrocketing oil and other energy prices are multiplying pain in the recovering economy even if GDP growth and rising inflation do not match stagflation of the 1970s, said Kathy Jones, managing director and chief fixed-income strategist for the Schwab Center for Financial Research.

"Consumers are very sensitive to rising prices for gasoline since it's something they tend to purchase regularly and notice price changes," Jones said. "In areas where people need to drive a lot — it hurts the pocketbook. Rising wages may not be enough to offset the increase."