Market Note: Signs of stagflation continue to percolate

The late 1970s to early ‘80s count as the worst extended period for the US economy since World War II. The problem was stagflation: a combination of weak economic growth and high inflation.

It wasn’t pretty for financial markets. Stock and bond prices plunged, with the 30-year Treasury bond peaking at 15%. Federal Reserve Chair Paul Volcker had to implement massive interest-rate increases to restore order, at the cost of two recessions.

Things aren’t that dire now, but stagflationary signs have arisen, as was noted in Quantfury Market Insights Feb. 26. The latest indication of trouble came Friday in the personal consumption expenditures (PCE) report. Real personal spending climbed only 0.1% in February from January. 

And the PCE price index, the Fed’s favored inflation measure, rose 2.5% in the 12 months through February (2.8% excluding food and energy). That far exceeds the central bank’s target of 2%.

U.S. tariffs are another factor fueling stagflation. And they expanded to the auto sector this week. Tariffs cause inflation, as exporters raise their prices to compensate for the taxes they must pay. And they restrict growth by making businesses and consumers hesitant to spend.

The specter of stagflation has put the kibosh on stocks, with the S&P 500 dropping 9% from its Feb. 19 record high. It could be that stagflation doesn’t get any worse. But it’s also possible that US tariffs lead to a trade war that generates more stagflation, hurting all the capital markets.

So as an investor, proceed with caution.