Stagflation is at the gates

Inflation rising while at the same time the economy is in conditions of great uncertainty while the phenomenon of stagflation due to trade turbulences and geopolitics seems that is at the gates. In fact, today the world economy is facing two issues that can cause stagflation.

One issue concerns the supply chain, which is yet disrupted by the coronavirus pandemic. Still today, supply remains lower than demand as companies cannot so far produce under conditions of normality. So, they cannot serve the demand for products. Until the supply chain returns to normal, the shortage of products will continue to pull prices and hence inflation upwards.

The second and most serious issue concerns the war in Ukraine. This war caused an explosion in energy prices which could only be compared to the shock of the oil crisis of the 1970s. Given that no one can end the war nor offer cheap energy, energy prices will hardly decline while keeping inflation high.

Indicatively, inflation for the OECD Member States in February or March is shown in the chart below.

As energy prices continue to rise or remain high and companies pass on their higher energy costs to consumers, unions will demand higher wages to offset rising inflation. This in turn will increase the operating costs of the companies which will be obliged to reduce the number of staff. Under these conditions and with high inflation as unemployment will increase demand will decrease and the economy will slow down.

Combining supply chain arrhythmia with high energy costs, high inflation, rising business costs, and rising unemployment is likely to lead to a recession in global economies, thus leading to stagflation in a significant number of economies. The phenomenon of stagflation characterized by slow economic growth and relatively high unemployment accompanied by rising prices is difficult to manage.

Central banks to curb high inflation could raise interest rates, but this policy would reduce demand and productivity leading to a slowdown. While, given that due to the pandemic worldwide the level of debts of government and businesses increasing as well as the level of debt in the private sector remains high, high-interest rates would make debt repayment unbearable.

Thus, central banks are more likely to continue to provide liquidity and keep interest rates at low levels to boost economies. With inflation remaining much higher than interest rates, targeted investments will be made in new forms of energy production and cutting-edge technologies in balancing the supply chain.

In this environment, real yields on government bonds and deposits will remain quite negative, while opportunities arise for companies and supply chain industries that are not directly affected by energy costs. At this stage, geographical diversification with the imperative correlation analysis and continuous trading rebalancing, as well as positions in inflation-indexed bonds is considered a wise strategy as instability and inflation will remain for a long time globally in the economy, markets, and everyday life.