The jaws of the stagflationary crocodile are opening and why investors are getting concerned

Few economic scenarios cause as much angst over the future health of family office finances as stagflation. Which makes the below graph unusually worrying.

The graph uses data from Citigroup to show a dramatic increase in the scale of US inflationary surprises, against expectations, and a severe fall in pleasant surprises from economic forecasts. Tilo Marotz, head of liquid investments at German insurer Continentale, compares the yawning gap to the jaws of a stagflationary crocodile.

In stagflation, commodity and basic material prices skyrocket due to supply shortages, increasing manufacturing costs and weakening the economy. Central banks find it hard to deal with inflation by raising interest rates while companies are suffering. 

As a result, currencies can weaken dramatically further increasing the cost of imported materials. Ultimately workers demand higher pay to cover their costs, leading to yet higher inflation and renewed pressure on the economy.

Family Capital warned last year stagflation could result from over-stimulation of the economy to deal with the pandemic and higher commodity prices, similar to the US experience of fifty years ago.

Professor Tim Congdon has forecast that stimulus could be followed by a surge in inflation. Economist Ken Rogoff has warned of continuing supply chain dislocation. Since then, bond prices have fallen, though they have regained some ground.

It is too early to say whether Marotz’ crocodile jaws will cause real pain. Some say the sharp change in expectations is part of the excessive speculation which now surrounds macro forecasting. 

There are also exceptional factors driving the two trends and underlying data is not so extreme. The latest US CPI inflation data was no worse than expectations, although it stayed at a 13 year high of 5.7% in July.

Few investments perform well in stagflationary conditions, aside from the commodities which cause the problem in the first place. 

It is interesting, however, to see a continuing flow of capital into tech-driven venture capital, which could be nicely positioned to compete with companies weighed down by a mounting burden of costs.