Fear of Stagflation Haunts U.S. Markets

Medo de Estagflação Assombra Mercados dos EUA

Katherine Buso (*)

The persistence of inflation and the aggressive trade policies of President Donald Trump have reignited fears of stagflation, a worrying combination of slow economic growth and high inflation that plagued the United States in the 1970s.

Although markets remain optimistic about Trump's pro-growth agenda, the possibility of stagflation has emerged as a significant risk for investors.

The Return of the Stagflation Specter

Stagflation, a scenario marked by high inflation and stagnant economic growth, is not a new threat to markets. However, in recent months, the combination of protectionist policies, trade tariffs, and persistent inflationary pressures has brought the issue back to the forefront of discussions.

Recent government data showed that consumer prices rose in January at the fastest pace since August 2023, pushing the annual inflation rate to 3%. Meanwhile, Trump's tariffs on steel, aluminum, and Chinese imports are increasing costs for consumers and businesses, potentially slowing economic growth.

"Stagflation has definitely re-emerged as a real possibility," said Jack McIntyre, fixed-income strategy manager at Brandywine Global. "We have policies that could harm consumer demand while persistent inflation limits the Federal Reserve's ability to act."

The Impact of Tariffs and Trade Policies

Trump delayed imposing new tariffs on imports from Canada and Mexico in early February but has already implemented a 10% tax on all Chinese products and announced global tariffs on steel and aluminum. Additionally, the president has ordered his economic team to develop plans for reciprocal tariffs against countries that tax U.S. imports. Recently, he also announced plans to impose 25% tariffs on cars, semiconductors, and pharmaceutical products.

While these measures are intended to protect domestic industries, they could have significant side effects. Tim Urbanowicz, chief investment strategist at Innovator Capital Management, pointed out that tariffs act as a tax on consumers, squeezing corporate profits and economic growth.

Investors' Perspective

A recent Bank of America survey of global fund managers showed that the proportion of investors expecting stagflation in the coming year has reached a seven-month high. Despite this, many remain optimistic about the stock market, considering the risk of a trade war to be low.

Some investors believe the negative impact of tariffs on growth will be temporary. Maddi Dessner, head of asset class services at Capital Group, argued that, in the long term, tariffs could even promote growth by benefiting industries facing less global competition. However, she acknowledged that the initial effect could increase inflationary pressures.

Comparisons with the 1970s

The stagflation of the 1970s was driven by supply shocks, such as rising oil prices, and unanchored inflation expectations. This time, core inflation remains around 3%, well below the levels of that decade, when the annual average was approximately 7%. Additionally, inflation expectations are more stable, reducing the risk of an inflationary spiral.

However, Mark Zandi, chief economist at Moody's Analytics, warns that the market may be underestimating the risks of stagflation. He noted that policies such as mass deportations of undocumented workers, another Trump campaign promise, could also fuel inflation and harm growth.

Investment Strategies in a Stagflation Scenario

Investors concerned about stagflation are seeking protection in assets like gold, which hit a new all-time high this week. Gold is considered a store of value in environments of high inflation and low growth. Additionally, long-term Treasury bonds, such as 10-year notes, could benefit in a slow-growth scenario, while short-term bonds, like two-year notes, tend to lose value with high inflation.

Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, noted that the increased interest in gold reflects investor concerns about stagflation. However, many managers are still not making drastic changes to their portfolios. "We're not there yet," said McIntyre of Brandywine Global, explaining why he is avoiding shifting to cash-like fixed-income instruments.

Conclusion

Although stagflation is not yet a reality, the risks associated with this scenario are increasing. Trump's trade policies, combined with persistent inflation, create a challenging environment for investors and policymakers. While some believe U.S. economic growth will remain resilient, others warn of the need for caution and preparation for potential shocks.

In this context, diversification and attention to protective assets, such as gold and long-term bonds, may be key strategies for navigating an increasingly uncertain market.

Katherine Buso is an expert in Economics and International Affairs, graduating with academic honors from the Armando Álvares Penteado University (FAAP-SP) in 2014. She holds a postgraduate degree in Statistics from the Pontifical Catholic University (PUC-Chile). She is an Editorial Consultant at Ciência Capital, an International Columnist at Rádio Alta Potência, and an International Columnist at Rádio Agro Hoje. She is also the CEO of Business Intelligence at BlueBI Solution in São Paulo.

Instagram: @bluebisolutionWhatsApp: +56 98484-9704LinkedIn: Katherine Buso

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