The risk of stagflation is growing
Since inflation started to break out of the trend, the two years US treasury rate has dramatically shot up while the ten years rate has stayed basically flat.
The chart enclosed may foretell the future of the economy and financial markets over the next 2-3 years. Since inflation started to break out of the trend, the two years US treasury rate has dramatically shot up while the ten years rate has stayed basically flat (see chart). The inconsistency is only apparent. The two years is discounting some tightening from the Fed while the ten years is assuming the same tightening will impair the economy, prompting the central bank to reverse its course. We have seen this pattern playing out a few times over the last decade but this time the context has changed significantly as inflation is now an issue. The unprecedented stock of global debt and governments’ insatiable addiction to deficit spending cripple central banks’ ability to remove liquidity from the economy to tame inflation. Even with some perfunctory tightening, the economy and asset markets are likely to decline. Political pressure and the terror of 1920’s type of policy mistake will force the Fed to stand by. The various drivers for inflation so often opined on these posts (https://lnkd.in/gPrF_Dqr) are likely to persist and lead to a stagflationary situation where the system is mired into a combination of economic stagnation and inflationary pressure. Should inflation stay too elevated, we may have a classic “spiral” where expectations for higher prices feed into the system pushing the annual increase into double digits. History shows that such instances unleash political and geopolitical instability and prompt governments into draconian action. A very seeming scenario for the 2020s is the deployment of newfangled tools, i.e. CBDCs and AI, combining monetary and fiscal policy and enabling unprecedented ability of the state to tax, redistribute and direct economic behavior. As financial institutions, pension funds and wealth managers are paralyzed by recency bias, conflict of interests and commitment to legacy allocation models, most investors’ portfolios will be ravaged in real and/or nominal terms. An unfortunate, but also inevitable, outcome if the massive stock of global debt is to be worked out. It is time to Swerve and cognizant investors may want to start exploring alternative paradigms to protect and manage their wealth.