High Inflation, Slowing Growth Raise Risk Of Global Downturn
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High Inflation, Slowing Growth Raise Risk Of Global Downturn

Yellen cites ‘stagflationary effects’ in a warning ahead of a meeting of leaders of seven wealthy nations.

By Josh Mitchell
Thu, May 19, 2022 10:43amGrey Clock 4 min

The global economy is in danger of entering a period of so-called stagflation, or high inflation and weak growth, policy makers and corporate leaders say, which could erode living standards around the world.

United States Treasury Secretary Janet Yellen on Wednesday became the latest leader to warn of turbulence for the global economy. “Certainly the economic outlook globally is challenging and uncertain,” Ms. Yellen said in Bonn, Germany, ahead of a meeting of leaders of seven wealthy nations. “Higher food and energy prices are having stagflationary effects, namely, depressing output and spending and raising inflation all around the world.”

Growing fears of high inflation rippled through financial markets Wednesday after large retailers reported disappointing earnings due in part to their own higher costs. The Dow Jones Industrial Average fell more than 1,164 points, or 3.6%, as of 4 p.m. ET in its worst day since 2020. The tech-heavy Nasdaq fell more than 4%. Target Corp. shares sank 25%, putting the company on track for its largest single-day percentage decline since 1987.

Ms. Yellen—a former Federal Reserve chairwoman—indicated that inflation, particularly the rising cost of food and energy, is becoming a greater longer-term concern and will be a dominant theme among global leaders in the weeks and months ahead. She added that the strong U.S. economy could help buffer it from the threat.

“The United States in many ways is best positioned, I think, to meet this challenge, given the strength of our labour market and the economy,” Ms. Yellen said.

A day earlier, Fed Chairman Jerome Powell warned that “there could be some pain involved” in the U.S. as the central bank moves to raise interest rates further to tamp down high inflation.

Meanwhile, Wells Fargo & Co. CEO Charlie Scharf said this week there was no question that the U.S. is headed for an economic downturn. “It’s going to be hard to avoid some kind of recession,” Mr. Scharf said Tuesday at The Wall Street Journal’s Future of Everything Festival.

Earlier this week, Ben Bernanke, also a former Fed leader, raised the possibility of stagflation in an interview published in the New York Times. “Even under the benign scenario, we should have a slowing economy,” he said. “And inflation’s still too high but coming down. So there should be a period in the next year or two where growth is low, unemployment is at least up a little bit and inflation is still high.”

Mr. Bernanke wasn’t available to comment, a spokeswoman said.

Inflation fears have risen in recent days because of new pressures that could further push up prices for oil and food from already-high levels. The European Union this week released a plan aimed at ending its dependence on Russian energy within five years. Rising food prices—also linked to Russia’s invasion of Ukraine, a major global producer of crops—are triggering shortages across the developing world. The U.K. government reported this week that inflation hit a 40-year high of 9% in April. That eclipsed inflation in the U.S., which hit 8.3% in April.

Meanwhile, economists have cut their forecasts for global economic growth this year as China and Europe show signs of a slowdown. China reported this week that consumer spending and output fell sharply in April as the government imposed new lockdowns to stem a wave of Covid-19 infections.

Last month, the International Monetary Fund said it sees the world’s economy expanding 3.6% this year, down from 6.1% last year. The most recent forecast was 0.8 percentage point lower than its projection in January and a 1.3 point cut from its October 2021 outlook.

The Bank of England earlier this month warned that the U.K. was likely to enter a recession.

One big factor behind the darkening outlook is signs from the Fed and the European Central Bank of a more hawkish stance to aggressively tackle inflation. The Fed last month raised interest rates by a half-percentage point—the biggest increase since 2000—and is planning additional increases this year.

ECB President Christine Lagarde indicated this month that she would support raising the central bank’s main interest rate in July, which would mark the first such increase in more than a decade. Higher interest rates mean that the cost of borrowing—for homes, cars, business expansions and other items—would go up, and could ultimately force consumers and firms to cut back, slowing inflation but also economic growth.

Even if the global economy avoids recession, many people could feel like they are in one, economists say. With the cost of living rising faster than most workers’ paychecks, consumers are getting less and less for each dollar they spend. Five dollars spent at the local cafe might get them a medium coffee instead of a large, for instance. Three hundred dollars spent on airfare might get someone from San Francisco to Denver, but not to Chicago.

Americans accumulated savings during the pandemic, as many reduced expenses and received government stimulus. That is now reversing. The saving rate fell in March to the lowest in nine years, according to the Commerce Department. Households are increasingly pulling out their credit cards and spending down their savings to keep up. Americans’ debt loads rose quickly in the year through March after stalling earlier in the pandemic, the latest Fed data show. As interest rates rise, monthly payments on that debt would further eat into household finances, economists say.

For now, the fundamentals of the U.S. economy are solid, with households still in a strong position financially as more people get jobs and return to old habits like travelling, dining out and going to concerts. Sales at American retailers—a big chunk of consumer spending, the biggest source of economic activity in the U.S.—rose in April for the fourth straight month, the Commerce Department said this week.

April’s unemployment rate of 3.6% remained just a shade above the 50-year low set just before the pandemic. Job openings across the U.S. reached a record high of 11.5 million in March.

But the risk of a recession has risen in recent weeks, and certain problems—such as supply chains disrupted by Covid-19 lockdowns in China and the Ukraine war—could be largely beyond the ability of central banks to address.

Diane Swonk, chief economist at the consulting firm Grant Thornton LLP, said one risk is that persistently high inflation would ultimately cause consumers to cut spending and businesses to slow hiring to maintain profit margins. If that happens, there would, for a period at least, be high inflation and rising unemployment—a combination generally known as stagflation that defined the 1970s, when oil shocks, high federal spending and loose monetary policy caused inflation to soar.

Unemployment could rise, as could homelessness, Ms. Swonk said. People could be forced to move in with parents and relatives and do away with healthcare, not to mention vacations and dinner outings.

“Inflation erodes living standards, and especially the kind of inflation we’re talking about—of basic needs—food and shelter and energy, the three pillars of existence,” Ms. Swonk said. “That kind of inflation is an incredible threat to the economy. We’re talking about a humanitarian crisis on top of what’s already been a pandemic and a war in continental Europe.”

Reprinted by permission of The Wall Street Journal, Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: May 18, 2022.



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The 7 lasting impacts of COVID for Australian investors

A leading Australian economist says two years on, the long term implications of COVID for the economy have emerged

By Bronwyn Allen
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AMP chief economist Dr Shane Oliver says the effects of the pandemic continue to reverberate across the world, with seven key lasting impacts leading to a more fragmented and volatile world for investment returns”.

Perhaps the biggest impact is that the pandemic related stimulus broke the back of the ultra-low inflation seen pre-pandemic,” said Dr Oliver. Together with bigger government and reduced globalisation, this means a more inflation-prone world. So, a return to pre-pandemic ultra-low inflation and interest rates looks unlikely.

Here is a summary of Dr Oliver’s explanation of the seven key lasting impacts of COVID for investors.

1. Bigger government

The pandemic added to support for bigger government by showcasing the power of government to protect households and businesses from shocks, enhancing perceptions of inequality, and adding support to the view that governments should ensure supply chains by bringing production back home. IMF projections for government spending in advanced countries show it settling nearly 2 percent of GDP higher than pre-COVID levels.

Implications for investors: likely to be less productive economies, lower than otherwise living standards and less personal freedom.

2. Tighter labour markets and faster wages growth

After the pandemic, labour markets have tightened reflecting the rebound in demand post-pandemic, lower participation rates in some countries and a degree of labour hoarding as labour shortages made companies reluctant to let workers go. As a result, wages growth increased, possibly breaking the pre-pandemic malaise of weak wages growth.

Implications for investors: Tighter labour markets run the risk that wages growth exceeds levels consistent with two to three percent inflation.

3. Reduced globalisation

A backlash against globalisation became evident last decade in the rise of Trump, Brexit and populist leaders. Also, geopolitical tensions were on the rise with the relative decline of the US and faith in liberal democracies waning ... The pandemic inflamed both with supply side disruptions adding to pressure for the onshoring of production [and] heightened tensions between the west and China we are seeing more protectionism (e.g.,with subsidies and regulation favouring local production) and increased defence spending.

Implications for investors: Reduced globalisation risks leading to reduced potential economic growth for the emerging world and reduced productivity if supply chains are managed on other than economic grounds.

4. Higher prices, inflation and interest rates

Inflation [due to stimulus payments to households and supply chain disruptions] is now starting to come under control but the pandemic has likely ushered in a more inflation-prone world by boosting bigger government, adding to a reversal in globalisation and adding to geopolitical tensions. All of which combine with ageing populations to potentially result in higher rates of inflation.

Implications for investors: Higher inflation than seen pre-pandemic means higher than otherwise interest rates over the medium term, which reduces the upside potential for growth assets like shares and property.

5. Worsening housing affordability

the lockdowns and working from home drove increased demand for houses over units and interest in smaller cities and regional locations. As a result, Australian home prices surged to record levels. Meanwhile, the impact of higher interest rates in the last two years on home prices was swamped by housing shortages as immigration surged in a catch-up. The end result is now record low levels of housing affordability for buyers

Implications for investors: Ever worse housing affordability means ongoing intergenerational inequality and even higher household debt.

6. Working from home

There are huge benefits to physically working together around culture, collaboration, idea generation and learning but there are also benefits to working from home with no commute time, greater focus, less damage to the environment, better life balance and for companies lower costs, more diverse workforces and happier staff. So the ideal is probably a hybrid model.

Implications for investors: Less office space demand as leases expire resulting in higher vacancy rates/lower rents, more people living in cities as vacated office space is converted, and reinvigorated life in suburbs and regions.

7. Faster embrace of technology

Lockdowns dramatically accelerated the move to a digital world. Many have now embraced online retail, working from home and virtual meetings. It may be argued that this fuller embrace of technology will enable the full productivity-enhancing potential of technology to be unleashed. The rapid adoption of AI will likely help.

Implications for investors: a faster embrace of online retailing at the expense of traditional retailing, virtual meeting attendance becoming the norm for many and business travel settling at a lower level.

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