recession?
Typically, slower growth or an actual recession cuts demand for products enough to curb prices. Based on the minutes from the Fed’s latest meetings, that seems to be what the Fed is banking on to keep inflation under control.
Other economists agree that current inflation pressures are typical for the start of a recession and that prices should be held in check by the coming downturn.
David Rosenberg, the chief North American economist for Merrill Lynch, wrote in a note Thursday that inflation should not be a major worry. Rosenberg is one of a growing list of economists who believe a recession has already begun.
He argued that commodity prices have only a limited impact on the cost of final goods and that wage growth is a bigger contributor to inflation. A weak job market should keep wages from rising sharply.
What’s more, Rosenberg said that “inflation is a lagging indicator and the Fed knows it.”
Inflation hawks: Dust off the bell-bottom pants
Still, there are reasons the economy could be heading for a period of stagflation.
The weakening dollar is a concern since it raises the price of dollar-denominated commodities, such as oil and other raw materials, as well as imported goods.
Ritholtz argues the weaker dollar is part of a longer-term trend that could keep price pressures building to very painful levels in the future.
“The big risk is not that we have stagflation today,” he said. “The risk is down the road this turns into a serious case of stagflation. If I had to guess where we are, I’d say we’re probably where we were during the oil shock of 1973-74.”
Ritholtz said that overseas demand from growing markets such as China and India are likely to keep prices for many goods high, even if consumption of those products falls in the United States.
“Unless we see a significant U.S. recession that causes a slowdown overseas, inflation may be stickier this time around,” he said.
More rate cuts may not be the answer
Argus Research’s Yamarone said he’s worried that the Fed seems to be willing to ignore its mandate to keep prices stable and this could lead to more inflation.
“The Fed has pretty much told us inflation is on the back burner,” said Yamarone. “Maybe inflation is not that alarming yet. But I think you’ll have this slow creep, and next year you know the pace will be significantly elevated.”
He added that if the markets lose faith in the central bank’s inflation-fighting credibility, long-term bond yields will shoot much higher.
Already, the yield on the benchmark U.S. 10-year Treasury note has climbed from an intraday low of 3.28% following the Fed’s emergency rate cut in January to about 3.8%
A bigger spike in long-term bond yields could be problematic because many rates that affect consumers and businesses, such as fixed-rate mortgages, credit cards and corporate debt, are more closely tied to long-bond rates set by markets than the short-term rates set by the Fed.
With all this in mind, Yamarone said the closely-watched CPI could jump as high as 6.5% this year. That would wipe out any chance for the economy to show gains when adjusted for increased prices, the most common measure of a nation’s economic growth.
In other words, even if the economy doesn’t actually decline, it may feel like it has to many consumers.
“This is how you get economic conditions to feel like a recession to the average person who has to feed his family and heat his house,” Yamarone said
