The US economy could go from the frying pan into the fire. After months or even years of planning for a recession, the country could face a different kind of disaster: stagflation.
A new report released yesterday by the Commerce Department showed that GDP growth slowed sharply while certain measures of inflation began to rise, leaving Wall Street concerned about exactly where the economy is headed. The long attempt to protect against an economic downturn, only to be confronted with the possibility of stagflation, has now rattled investors.
“I’m not worried about a single data point, but no one is really prepared for that scenario, and that’s hard to hedge against,” Mark Haefele, head of global asset management at UBS, told MarketWatch.
Most banks and economists forecast economic growth of 2.5% for the first quarter. Instead, it only grew by 1.6%. The same report showed that the personal consumption expenditures price index (PCE), the Fed’s preferred measure for measuring inflation, rose to 3.4% in the first quarter from 1.8% in the fourth quarter.
The fact that these two metrics matched made the latest data the “worst of both worlds.” The Fed wants inflation to fall to its 2% target, which hasn’t happened yet. But more worrying is the persistence of inflation and the difficulty of covering the so-called last mile towards this mark. At the same time, inventors want strong GDP growth to fuel a stock market rally. At the moment it looks like neither is happening.
The US economy is not yet hit by stagflation because the unemployment rate is not currently high, which is the third requirement. Unemployment is currently below 4%, indicating a healthy labor market.
Stagflation is a special one difficult situation to cope, as attempting to address one contributing factor can sometimes worsen the others. This also causes great concern for investors as it means they no longer have a reliable source of returns. During times of low growth and high interest rates, the stock market suffers, while the bond market declines during times of high inflation.
While Haefele is right to point out that a single disappointing report does not mean stagflation is certain to occur, the market was unsettled. Yesterday the S&P 500, the Dow and the Nasdaq Composite fell. Some technology stocks also fell this week as investors worried that the possibility of higher inflation would lead to higher interest rates, although some of those stocks have since recovered after initial worries stabilized.
For his part, Haefele told MarketWatch that he expects inflation to slow enough in the second half of the year to give the Fed room to lower interest rates. And he wasn’t the only one to offer perspective. Treasury Secretary Janet Yellen said the economy is on solid footing despite weak growth numbers. “The economy is clearly doing very well,” Yellen told Reuters on Thursday. “I definitely don’t see it as overheating. The job market is the strongest job market we’ve had in 50 years.”
Others on Wall Street also preferred to look for the silver lining despite the looming dangers. “Another positive GDP reading further strengthens the soft landing argument,” Mike Reynolds, vice president of investment strategy at Glenmede, wrote in an analyst note.
This story was originally published on Fortune.com