If the United States is already stagflating, then what comes next... [Shun Nakahara's Today's Word] Updated July 27

From Stagflation to Recession

At last month's study session I pointed out that “the United States is already in stagflation.” Many strategists and economists argue adamantly that it is not stagflation by looking at factors like employment, but in reality they are mistaken. While consumer prices keep rising, the economy is already showing signs of “stagnation” in various sectors. By July, the weakness of the U.S. economy in the second quarter is evident like a flame.

Moreover, stagflation is happening now, but a recession is also increasingly certain to arrive. In the previous study session, I noted that inflation would temporarily subside during the recession stage. What the market is catching up to now is this world. In fact, indicators suggesting a recession are coming out one after another. New home sales have fallen into negative territory; the Consumer Confidence Index has fallen for three consecutive months since May and has remained below 100 for two consecutive months. The Dallas Fed’s manufacturing activity index has deteriorated further, turning negative at -22.6%. Durable goods orders are negative, and Philadelphia’s manufacturing is weak, so production activity is clearly braking. The PMI has fallen below the 50 threshold, which distinguishes the direction of the economy, for both the overall and services sectors.

IMF, as expected, has downgraded its outlook. It warned that “the world economy faces a risk of approaching recession,” but even so, the forecast seems optimistic. Of particular note is that the United States’ growth rate was downgraded the most. From 3.7% to 2.4%, a cut of 1.3%, but that remains an optimistic projection. A growth rate of 2.4% is a high hurdle. Q1 is already negative, Q2 looks roughly around zero at best, and I likely see it as negative. To achieve an annualized 2.4% growth, GDP growth in Q3 and Q4 would need to average above 3.5%. I see that as entirely unlikely. A recession is a realistic expectation. When these uncomfortable truths become blatantly clear, how will the central bank and the government respond? Now that Q2’s “absolute poor performance” is becoming certain, it will be fascinating to watch when and how the administration and the Fed adjust their stance.