The U.S. economy has long enjoyed what might be called a Goldilocks scenario: robust growth paired with gradually declining inflation. However, recent data suggest that those days are behind us.
Take, for example, the recent GDP figures which illustrate a stark downturn. After quarters of 4.9% and 3.4% growth, the economy slowed to a mere 1.6% annualized growth in the first quarter of this year.
Even more concerning is the surge in the Core PCE deflator—the Federal Reserve’s favored gauge of inflation—which leapt to 3.7% in the first quarter, nearly double its previous rate and well above the Fed’s target. This combination of weakened growth and heightened inflation hints at the onset of stagflation, a scenario of low growth coupled with high inflation that poses a serious challenge for central banks.
This troubling economic landscape is already impacting financial markets, which are feeling the pressure of the recent high inflation rates. Despite this, I anticipate a significant cooling in the economy. Historical trends, such as the rapid decline in the ‘economic surprise index,’ suggest that unemployment will soon start to rise, a classic aftermath of tightening monetary policy.
Such economic conditions typically lead central banks globally to lower interest rates. This is emphasized when considering the current high U.S. two-year rate, the highest since 2007, against the backdrop of historically lower rates during similar past inflationary periods.
Clearly, our current model of debt-fueled growth cannot sustain double-digit interest rates; even rates at 5% have historically led to economic distress. The Federal Reserve and its international counterparts are keenly aware of these limitations. It’s a delicate balancing act, waiting for the opportune moment to adjust policy effectively.
Jeroen Blokland, the founder and manager of the Blokland Smart Multi-Asset Fund and founder of True Insights, offers this perspective. His weekly chart analysis on Investment Officer highlights key economic trends and their investment implications.