Uncover stagflation’s impact on the US economy, a blend of inflation and reduced output. Experts’ warnings, gold as a hedge, and implications for savings and investments

The looming specter of stagflation has cast a shadow over the American economy for some time now. This might appear counterintuitive, given the consistently robust data typically associated with a thriving economy.

To delve into the matter, stagflation is a relatively infrequent occurrence in the economic cycle, characterized by the simultaneous presence of inflation and reduced economic output. So far, we’ve witnessed the inflationary side of this equation, but some analysts remain concerned that the “downturn” phase may be lurking just around the corner.

Since March 2022, the Federal Reserve has executed a remarkable 11 interest rate hikes, marking the fastest pace of increases in the past four decades. Despite these developments, the headline indicators reflecting the economy’s health continue to suggest it’s in excellent condition.

For instance, despite the series of rate hikes, the unemployment rate remains at its lowest point in nearly half a century. Consumer spending has also remained strong throughout 2023. Furthermore, the most recent data reveals that the third and final estimate for annualized GDP growth in the second quarter stood at a solid 2.1%.

This doesn’t paint the picture of a recession. Nevertheless, the current reality may be concealing what lies ahead on the economic horizon.

This is because, according to analysts and economists, the effects of the Federal Reserve’s interest rate hikes are still percolating through the nation’s economic framework. They anticipate that signs of an impending recession will become increasingly evident.

Economist David Rosenberg is among those who believe that the economy may not have completely averted the threat of a recession. He points out a crucial factor that is presently underappreciated – the likelihood that the rapid rate hikes by the Fed have yet to fully manifest their impact.

Rosenberg recently explained, “Normally, it takes two years after the first rate hike by the Fed for a recession to take hold. We’re not going to avoid a recession.”

“The recession has been postponed, but it hasn’t been averted,” Rosenberg emphasized.

As for the reasons behind his view, he cites various factors, including clear indications of increasing consumer credit delinquencies. Rosenberg also believes that consumer spending may be on borrowed time due to projections suggesting that the substantial $2.1 trillion in excess savings accumulated during the global health crisis could be exhausted by the end of the third quarter. This is particularly significant as consumer spending accounts for 70% of GDP.

Additionally, there are concerning readings in the vital manufacturing sector of the economy. Although there have been slight improvements, both the Institute for Supply Management and S&P Global’s purchasing managers’ indexes continue to signal contraction.

Stagflation, however, isn’t solely a byproduct of an economic downturn; it also hinges on inflation. There are indications that inflation, although moderating somewhat, may persist for some time.

Most recently headline inflation, as measured by the August consumer price index, registered at 3.7% year over year, marking an increase from the 3.2% rate observed in July. As for core inflation, which is typically less volatile, it did decelerate from July (4.3% compared to 4.7%), but it remains firmly above 4%.

The prospect of an economic downturn coinciding with elevated inflation in the coming months raises the specter of stagflation. In a recent interview with the Times of India, J.P. Morgan CEO Jamie Dimon discussed how this could impact central bank policies, a perspective that has been given relatively little consideration.

Dimon: “In the worst-case scenario, we could see stagflation with a 7% outcome.”

Dimon’s primary concern revolves around central bankers facing the daunting task of combating inflation at a particularly precarious juncture for both domestic and global economies.

To lay the foundation for his apprehensions, Dimon makes a noteworthy observation about the initial stages of interest rate hikes in this cycle.

“First of all, interest rates went to zero,” Dimon pointed out. “Going from zero to 2% was almost negligible.”

This assertion holds weight, especially during a period officially marked by high inflation. The Federal Reserve began raising rates in March 2022 when the inflation rate stood at 8.5%. The magnitude of that first rate increase? A mere 25 basis points (with a touch of sarcasm).

In essence, the challenges posed by rate hikes in those initial months seemed relatively minor compared to the trials posed by inflation.

Dimon continued, “Going from zero to 5% caught some people off guard, but no one would have considered 5% out of the realm of possibility.”

“However, I am not certain if the world is prepared for 7%.”

Did he mention 7%?

“I ask business people, ‘Are you ready for something like 7%?’ The worst-case scenario involves 7% with stagflation.”

Certainly, stagflation remains a conceivable scenario. As discussed earlier, headline inflation has recently accelerated. While core inflation has been slowing, it remains comfortably above the Fed’s 2% target. These inflation rates persist as projections hint at a downturn and a potential recession.

We previously referenced economist David Rosenberg’s recession prediction, and there’s another perspective to consider.

“US economic growth will buckle under mounting challenges early next year,” asserts Erik Lundh, Principal Economist at The Conference Board, “resulting in a brief and shallow recession. This outlook is influenced by various factors, including elevated inflation, high interest rates, diminishing pandemic-related savings, growing consumer debt, reduced government spending, and the resumption of mandatory student loan repayments.”

Lundh goes on to suggest that these factors will significantly impact GDP next year, reducing it from a projected 2.2% in 2023 to a mere 0.8% in 2024. If inflation persists while output declines, it creates a situation akin to stagflation.

Dimon adds, “If they are going to have reduced economic activity and higher interest rates, stress will be evident in the system.”

The potential scenario of the U.S. economy grappling with stagflation prompts a consideration of what actions retirement savers might take to mitigate its impact on their savings.

Interestingly, while the challenge of combating higher inflation alongside low output is formidable, one of the world’s leading hedge funds suggests that there may be an asset that could offer some assistance.

Let’s delve into that topic as we conclude this week’s article.

The World Gold Council suggests that in the context of stagflation, gold could receive additional support.

Bridgewater Associates, the world’s largest hedge fund, stands out not only for its substantial managed assets but also for its pronounced affinity for gold. This includes the firm’s founder, Ray Dalio, who has consistently expressed his fondness for gold publicly.

In the past year, Bridgewater’s Chief Investment Strategist, Rebecca Patterson, had her eye on stagflation and emphasized the potential value that gold could bring in mitigating its impact.

Patterson and her Bridgewater team delved into economic scenarios and asset performance spanning a century, seeking to identify assets that exhibited strength during stagflationary conditions. Among their findings, gold investment emerged as a noteworthy asset, puns fully intended.

Reinforcing the case for gold investment planas a hedge against stagflation is analysis by the World Gold Council, which suggests that stagflation and gold are a potent combination.

According to the council’s report, stagflation is a climate that is exceptionally favorable for gold investment. In fact, the WGC’s research reveals that gold in U.S. dollars has been the top-performing asset during stagflationary periods since 1973.

The WGC notes, “Should stagflation become widespread, it could provide further support for gold trade market as a diversifier and risk hedge.”

One of the most compelling historical examples of gold trade investment’s ability to thrive during stagflationary periods was the “Great Inflation” of the 1970s and early 1980s. During this era, inflation surged, with the consumer price index occasionally reaching double digits while rarely dropping below 6%. The economy also experienced three recessions during this time. Throughout these challenging years, gold’s value increased by nearly 600% and silver also performed strongly with a 435% climb.

Returning to the present, the economic outlook remains highly uncertain. While some anticipate a recession, others do not. However, very few envision a “Goldilocks” scenario with no slowdown at all. It’s more likely that some degree of downturn will occur.

Then there’s the persistent issue of inflation, as discussed earlier. Many experts anticipate that inflation will continue to be a significant concern. Economist Mohamed El-Erian recently noted, “Headline inflation is going to prove much more complicated, and I think core inflation will be less well-behaved.”

Considering the Federal Reserve’s determination to bring inflation back to 2%, this could lead to prolonged periods of higher interest rates. In the view of J.P. Morgan’s Jamie Dimon, it could even result in significantly higher rates. If the economy finds itself contending with higher inflation, elevated interest rates, and lackluster growth, as Dimon suggests, stagflation could become a reality. In such a scenario, the already intricate landscape for savings and investments could become even more complex.