Is the soft landing too optimistic? Wall Street is concerned that the US economy may fall into stagflation.

Recently, the continuous higher-than-expected inflation in the United States has raised concerns among some analysts on Wall Street. They believe that investors are overly optimistic about the possibility of a "soft landing" for the U.S. economy.

The mainstream concern is that inflation may enter a period of stagflation, where prices continue to rise while economic growth slows down. This situation occurred in the 1970s to 1980s when a brief decline in inflation rates was eventually proven to be a "false signal," leading the United States to spend over a decade combating the rising price levels.

Marko Kolanovic, Chief Market Strategist at JPMorgan Chase, pointed out in a report in February:

The U.S. economic narrative may shift from a "golden-haired girl" scenario to a stagflation similar to the 1970s, which will have a significant impact on asset allocation. It is expected that the Pro UltrPro Shrt S&Pro 500 will fall to 4200 points by the end of the year.

The consecutive higher-than-expected inflation reports in January deepened the concerns of Kolanovic and other analysts. They believe that the path for inflation to return to the Federal Reserve's target of 2% is challenging.

Michael Arone, Chief Investment Strategist at State Street Global Advisors, stated:

Although unlikely, investors may underestimate the possibility of stagflation occurring in the next 12 to 18 months. If stagflation does happen, the performance of tangible assets such as commodities will outperform stocks and bonds. Allocating 5% to 10% of assets to such tangible assets in the event of this low-probability event will benefit investors.

Intensifying Inflation Debate

Michele Schneider, Chief Market Strategist at Market Gauge, highlighted in a report in January that "stagflation" is a significant risk for 2024. She pointed out the striking similarity in the CPI trends from the late 1970s when she started her market analysis work until now.

In the inflation of the 1970s and 1980s, the oil embargo and conflicts in the Middle East collectively drove up inflation rates. The massive government spending during and after the Vietnam War was also one of the reasons for price increases.

These factors make the current situation quite similar to the past, with the pandemic and its subsequent recovery leading to soaring inflation rates, conflicts in the Middle East pushing up oil prices and causing supply chain issues, and government spending being a focal point.

Schneider pointed out that there have been some warning signals in the commodity markets, indicating an upward trend in inflation.

Currently, sugar futures prices are four times higher than pre-pandemic levels, cocoa futures prices have also surged, and Invesco's agricultural ETF (DBA) prices are approaching the highs during the inflation surge in 2022. The issues in the food sector bear striking similarities to the situation in 1979. In addition, the price of oil has surpassed $80 per barrel for the first time since November last year. Many factors that led to inflation in the late 1970s are now replaying, but the outstanding performance of silver futures compared to gold has not yet emerged.

Nevertheless, many economists insist that inflation is on a downward trend. Paul Ashworth, Chief North American Economist at Capital Economics, believes that this round of inflation is more similar to post-World War II price increases and will not turn into stagflation.

In sharp contrast to the 1970s, when a series of supply shocks occurred, the focus this year is on further increases in oil prices. However, currently, oil prices are still below the peak in 2022.

The unexpected growth of the U.S. economy over the past year suggests that productivity may have improved, indicating that the economy can remain balanced even with strong demand.

We believe that even with the Fed's response to interest rate cuts this year, demand will remain strong. Due to further room for improvement on the supply side of the economy, the probability of a short-term resurgence in inflation is low.