Sep 17, 2019

Top strategists warn about stagflation risk as China trade tensions remain

Dion Rabouin

While not yet sounding an alarm, top strategists at BlackRock are starting to worry about the possibility of U.S. stagflation — high inflation combined with high unemployment and stagnant demand.

What they're saying: Mike Pyle, chief investment strategist for the BlackRock Investment Institute, sees inflation as set to pick up "thanks to more tariffs and faster wage growth in the face of a tight labor market," he says in a note to clients.

  • "A mix of lower growth and higher inflation complicates the Fed’s effort to achieve maximum employment and stable prices."

Be smart: Despite a recent armistice between the U.S. and China on the trade war, BII strategists believe the tensions are underpinned by "structural" issues, reducing the likelihood of a meaningful deal and keeping the trade war brewing for some time.

  • "U.S. growth could fall materially below trend in coming quarters," Pyle says. And with China slowing and Europe struggling, the U.S. is "unlikely to get much help from the rest of the world."

The bottom line: "Trade tensions pose the risk of slowing growth and rising inflation — a potential threat to stock and bond markets alike."

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Why America isn't at full employment

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The Fed has two jobs: Keeping inflation at 2%, and ensuring full employment. But what does full employment mean? According to Minneapolis Fed president Neel Kashkari, we're clearly not there yet — despite the fact that the unemployment rate is at a 50-year low of 3.5%.

Why it matters: If we're not at full employment, and inflation remains below the 2% target rate (as it does), then the Fed has little choice but to step on the gas.

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The bears are in control now

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For much of the year, equity bulls bought stocks on even the faintest hint of good news about companies or the economy, pushing U.S. indexes to new all-time highs despite a slowing economy and negligible earnings growth.

Why it matters: But with the S&P 500 approaching 20% gains for the year and no real signs of growth to be found, a spirit of pessimism and increased caution looks to be gripping the market.

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