Investors are seriously underpricing the risk of 70s-style stagflation - and markets could be in for a long period of negative returns for stocks and bonds, Deutsche Bank says
REUTERS/Dario Cantatore/NYSE Euronext
- Markets are underpricing the risk of 70s-style stagflation, according to Deutsche Bank in a note.
- The bank pointing to persistently high inflation data, which could lead to high expectations of inflation becoming entrenched.
- That would prompt an even stronger rate response from the Fed, resulting in more pain for stocks and bonds.
Markets are seriously underpricing the risk of 1970s-style stagflation, Deutsche bank said, warning that investors could be in for long-term negative returns in both stocks and bonds.
Soaring inflation has helped spark a steep sell-off in the market this year, with the S&P 500 now 25% below where it started in January. Some market bulls have pointed to easing inflationary pressures, which could fuel a rally before year-end – but those investors are underestimating the risk of inflation becoming entrenched in the economy, Deutsche analyst Henry Allen warned in a note on Monday, which could bring more headwind to stocks and bonds.
"Markets are neglecting the fact that we are increasingly at risk of returning to prolonged 1970s-style stagflationary dynamics, which would require an even larger interest rate response. If the experience of the 1970s repeats, investors are in for a prolonged period of negative real returns for both bond and equities," Allen said.
Allen pointed to the fact that inflation has remained high for a significant portion of this year, with headline Consumer Price Index reaching a 41-year-high of 9.1% in June, and barely easing to 8.2% in September. Additionally, "sticky" prices – prices for goods and services that don't change frequently – are still accelerating in the economy.
Those indicators are "seriously bad news," Allen said, as the longer inflation stays higher, the more likely inflation expectations will get entrenched in the economy. He pointed to recent data from the University of Michigan, which found three-year and five-year inflation expectations have ticked higher, despite consecutive declines in previous surveys.
"It is true that could just be a blip, but a further reversal would raise the question as to whether the Fed's actions to date have proven insufficient," Allen warned.
There's also evidence Fed policy is not yet restrictive enough to fully control inflation. Despite issuing aggressive rate hikes this year, the Fed's policy rate remains "deeply negative in real terms," Allen said. He estimates it's even lower than the real policy rate that was in play when the US battled inflation during the 70s – which led the economy to spiral into a deep recession in the early 80s.
And while some argue inflation has been triggered by idiosyncratic factors, such as the pandemic and Russia's invasion of Ukraine, that doesn't rule out more idiosyncratic events fueling more inflation, Allen warned.
"As in the 1970s, seemingly transitory shocks have coalesced to keep inflation high. We cannot rule out more occurring," he said.
His view echoes the warnings of other experts. Top economist Nouriel Roubini warned the US could be in for a stagflationary debt crisis, which he said could wipe out as much as 40% of the stock market's value.
"This is not an idle warning. Inflation has become increasingly broad-based and persistent," Allen added.
Contributer : Business Insider https://ift.tt/DWtyA5i
Reviewed by mimisabreena
on
Tuesday, October 18, 2022
Rating:
No comments:
Post a Comment