In a situation reminiscent of the 1980s, fears of stagflation are beginning to emerge in global financial markets. As a result, global equities have taken a beating as investors are fleeing to safe-haven US Treasuries.
The latest bit of news to unsettle markets was the slowdown in US economic growth in the 1st quarter of 2005. Data released last week showed that US economic growth slowed down from 3.8% in the fourth quarter of 2004 to 3.1% in the 1st quarter of 2005, compared to 4% growth in 3Q2004 and 3.3% in 2Q2004.
This is the slowest growth rate since the 1st quarter of 2003. The latest (March) consumer price data showed CPI inflation rising to 0.6% on a month-over-month (m-o-m) basis from 0.4% in February.
If annualized, this would result in a whopping 7.2% inflation rate! Even the core CPI inflation number, i.e., excluding the volatile food and energy categories, rose to 0.4% (m-o-m) from 0.3% the previous month.
And, oil prices remain close to recent records at $51-plus levels. As in the 1980s, the US faces slowing down of economic growth, rising inflation, record high oil prices and the US Fed showing no pause in raising interest rates.
Although, inflation is still nowhere near the double digit levels of the early 1980s, oil prices are still below their levels at that time in real terms and US economic growth is a still respectable 3.1%, what markets fear is a replay of the US monetary policy of that time.
Most economists agree that the catalyst that threw the US economy into a recession in the early 1980s amid high inflation (i.e., stagflation) was the US Fed’s response of raising interest rates. This time around, although interest rates are nowhere near the double-digit levels of the 1980s, the fact remains that the US Fed continues to raise interest rates without pause.
In its latest policy meeting on May 3, the Federal Open Market Committee has raised interest rates for the eighth time in the last one year (since June 2004). With the latest raise, the federal funds rate now stands three times its level before the Fed embarked on this journey.
In other words, borrowing costs, although still low, are three times higher than their year ago levels. Friday’s much better-than-expected job growth number has muted the market’s stagflation fears for the time being while heightening interest rate hike fears.
The US Labor Department reported that Nonfarm payroll increased by 274,000 in April (vs. 175K expected) and the number for February and March were also revised up by a combined 93,000.
Markets will now be looking for additional signs ahead that this strong job growth number really reflects a sustained rebound in the US economy, or it is just a temporary phenomenon.
Domestically, SAMA released its March data showing yet another record increase in liquidity. M3, the broadest measure of liquidity rose by SR17 billion in March, the second largest monthly increase on record (the highest was on Nov. 2004, when it rose SR39 billion due to the Etisalat IPO). This time it maybe Albilad IPO.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)