The spectre of US stagflation is stalking global markets, prompting investors to adjust their portfolios to mitigate potential risks. A recent survey by BofA Global Research revealed that approximately 70 per cent of global investors expect stagflation—characterised by stagnant growth and rising inflation—over the next year.
Concerns have intensified following recent data that indicates weaknesses in the US labour market, a spike in core inflation, and an unexpected rise in producer prices. These factors have led to an unease about the economic landscape, with many investors bracing for the consequences of tariffs that could exacerbate growth and inflation issues.
Us stagflation: Bond Markets on Edge
Persistent inflation, or the anxiety surrounding it, can severely impact longer-dated bonds as the real value of fixed interest payments diminishes over time. Paul Eitelman of Russell Investments, which manages over $1 trillion in assets, noted that pension funds and insurers are increasingly apprehensive about the effects of inflation on their bond portfolios. He remarked, “If we had another very weak employment report, that would significantly ramp up US stagflation concerns.”
Non-US bonds may not provide much refuge either. Mayank Markanday, a portfolio manager at Foresight Group, explained that interest rates and long-term bond yields are closely linked across G7 economies. “If you see a big sell-off in the long end of the US curve, we are likely to see an impact on some of the others,” he said. This aligns with the observed trends, as long-dated bonds have already seen a sell-off in major markets.
Wall Street’s Mixed Signals
On Wall Street, the outlook remains cautious yet optimistic. Caroline Shaw from Fidelity International indicated that the firm anticipates a slowdown in US growth, with stagflation being one of their two primary scenarios. While she remains bullish on large technology stocks, she has also taken protective measures by purchasing put options on the Russell 2000 small-cap index, anticipating that it may fall.
Historical data suggests that global stock markets often struggle during periods of US stagflation. According to Michael Metcalfe, head of macro strategy at State Street, world stocks have typically declined by an average of 15 per cent during times when US manufacturing activity showed a contraction alongside rising prices. Nevertheless, current stock performance remains robust, indicating that investors might believe that the disruptions to the global trading system won’t heavily impact the earnings of major tech companies.
Currency Fluctuations and Prospects
Nabil Milali from Edmond de Rothschild Asset Management has highlighted that signs point toward a looming stagflation in the US economy, predicting a further decline in the dollar against the euro. Stagflation poses dual threats to the US currency; weak growth tends to devalue it, while persistent inflation diminishes its purchasing power on the international stage. This year, the euro has appreciated by over 12 per cent against the dollar, with other currencies like the Japanese yen and British pound also gaining strength.
Investment Strategies Amid Uncertainty
As stagflation looms, investors face challenges in deciding where to allocate their funds. Some analysts suggest that gold could become an attractive asset, given its historical appeal during times of economic uncertainty. Kristina Hooper from Man Group noted that other assets, such as short-dated inflation-linked bonds, might also be appealing as they offer a hedge against inflation. Additionally, professional investors are increasingly exploring complex derivatives, such as inflation swaps, which rise in value when price indices exceed specific thresholds. The US two-year inflation-linked swap is currently at its highest level in over two years.
