Stagflation fears come back with a vengeance

US economy heading toward 'stagflation light': Booth

QI Research CEO and chief strategist Danielle DiMartino Booth discusses whether stubbornly high inflation data will delay Fed rate cuts on "Making Money."

Some Wall Street strategists are growing concerned the U.S. economy could be headed toward a 1970s-style stagflation scenario amid recent signs of stubbornly high inflation and a cooling economy.

A string of inflation reports during the first three months of 2024 all came in above estimates, fueling fears that inflation could prove more difficult to conquer than previously believed. On top of that, economic growth during the first quarter unexpectedly faltered, rising at an annualized pace of just 1.6% – the slowest rate since 2022.

"This was a worst of both worlds report: slower than expected growth, higher than expected inflation," said David Donabedian, chief investment officer of CIBC Private Wealth US, of the latest GDP data. "The biggest setback is the acceleration in core inflation, and in particular, the services sector rising above a 5% annual rate."

That combination of economic stagnation and high inflation is what's known as "stagflation," which is regarded as a worst-case outcome for the Federal Reserve.

FED'S FAVORITE INFLATION GAUGE RISES FASTER THAN EXPECTED IN MARCH

The phenomenon ravaged the U.S. economy in the 1970s and early 1980s as spiking oil prices, rising unemployment and easy monetary policy pushed the consumer price index as high as 14.8% in 1980, forcing Federal Reserve policymakers to raise interest rates to nearly 20% that year.

Stagflation fears surged in 2022 as the Fed began aggressively hiking interest rates to quell raging inflation, but those mostly dissipated last year amid signs that price pressures were subsiding without a substantial hit to economic growth.

WHY ARE GROCERIES STILL SO EXPENSIVE?

However, there have been some signs recently that inflation is proving to be stickier than expected, even as economic growth decelerates.

A woman shops for groceries at a supermarket in Monterey Park, California, on Oct. 19, 2022. (Frederic J. Brown / AFP / Getty Images)

While inflation has fallen considerably from a peak of 9.1%, progress has largely flatlined since the summer. The latest government data shows the consumer price index jumped 3.5% in March, the highest level in six months.

JPMorgan Chase CEO Jamie Dimon is among the experts who have sounded the alarm recently over a possible return to the stagflation scenario seen in the 1970s.

"I think there’s a chance that can happen again," Dimon, the chief executive of America's largest bank, said last week during a discussion at the Economic Club of New York. "I worry it looks more like the '70s than we've seen before."

JAMIE DIMON WARNS INFLATION, INTEREST RATES MAY REMAIN ELEVATED

Some Wall Street strategists are becoming concerned the U.S. economy could be headed toward a 1970s-style stagflation scenario. (John Taggart / Bloomberg / File / Getty Images)

Fed Chair Jerome Powell recently lamented a "lack of further progress" this year on inflation as he cast doubt on the outlook for interest rate cuts this year. While officials have kept the option of rate reductions on the table, they have said there is no urgency given the surprising strength of the economy and the risk of reigniting inflation.

Investors were previously betting on a series of aggressive rate cuts this year, but they have dialed back those expectations following the hotter-than-expected inflation reports and cautious messaging from Fed officials.

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Hiking interest rates tends to create higher rates on consumer and business loans, which then slows the economy by forcing employers to cut back on spending. Higher rates have helped push the average rate on 30-year mortgages above 7% for the first time in years. Borrowing costs for everything from home equity lines of credit, auto loans and credit cards have also spiked.

Yet the rapid rise in rates has not stopped consumers from spending or businesses from hiring, powering optimists on Wall Street who say the economy is not entering a stagflation scenario.

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The labor market is continuing to chug along at a healthy pace, with employers adding 303,000 new workers in March – substantially higher than economists expected. Job openings remain high, and the unemployment rate fell slightly to 3.8%.

"Incomes and consumer spending rose solidly in March, which should provide a little reassurance that the slowdown in first quarter GDP reported yesterday is not a sign of a stagflationary economy," said Bill Adams, chief economist for Comerica Bank.