Market volatility is rising as the chatter on stagflation grows louder. Kim Parlee speaks with Priya Misra, Head of Global Rates Strategy, TD Securities, about the risk of stagflation, Fed tapering, rate hikes and the U.S. debt ceiling showdown.
- So we are concerned that inflation is running higher than what anyone forecasted. Any private forecaster, the Fed, I think we were all looking for supply chain disruptions to ease as we came to the end of the year. We were looking for energy prices to sort of stay around current levels. And what we've had is the supply chain disruptions have lasted longer. And we've seen this perfect storm in the energy market resulting in high inflation.
So we are concerned about high inflation, but I think when-- you know, stagflation seems like a step too far, because growth is still strong. I mean, we're moderating from the 6%, 7% growth earlier in the year, which was reopening impacted, fiscal stimulus impacted. But we're still looking at a solid 4% growth in the fourth quarter, and 2.5% growth next year.
So more sort of calling it mod-flation, that it's moderating growth, high inflation, but inflation-- this kind of inflation, which is supply led and not demand led, is not persistent. And at some point, these inflation readings will also moderate, and then we are going to have a moderate growth, moderate inflation, rather than the stagflation of the '70s, which was-- it was a very different structure and labor market and economy at that point, and we had to deal with stagflation.
- Is there anything that would have you change your mind on that, though? Because I hear what you're saying. These are kinks that need to get worked out of the system. When we get things back to normal, hopefully things go back. But is there anything that might say, hey, this could be something we need to pay a little closer attention to?
- A couple of things. We are tracking consumer surveys and inflation expectations. If they get unanchored, if collectively the economy believes that inflation is going to be higher, you start asking for higher wages. It becomes this wage price spiral. And then I do think that it can get sort of unanchored. Then inflation can be more persistently higher.
And even if supply chain disruptions go away, we get used to high inflation. I think that's something central banks across the world are tracking, and so is the Fed. So that's something we're keeping track of right now, those inflation expectations in the long run. They look anchored. But again, I don't think we can take that for granted.
The other one is on the labor market front. You talked about the jobs report last week. It was weak. A lot of people left the labor force after COVID. They haven't come back. Now, our view is this is temporary. This was partly due to the Delta surge, or schools being closed. Over time, that's going to go away, and people re-enter the labor force.
But if COVID has been a structural impact on the labor market, if these people never come back to the labor market, and the market is a lot more tight in terms of the labor supply, I think then you start to see wage inflation. Then again, the risk is that the supply led temporary inflation-- transitory, as the Fed calls it-- starts to become more permanent, because now wages start rising.
So we're keeping a very close watch on labor force participation to see if the slack in the labor market comes back or how tight is it. So those are things we're watching, because it puts the central banks in general in a very uncomfortable situation. Because if they were to tighten policy in response to inflation, it's a double whammy for the consumer. I have to deal with higher mortgage rates, higher inflation, while my wages are not going up. So it's not the solution. But certainly, if inflation gets unanchored, I think that's when central banks would want to react.
- What does the Fed do with this, Priya? I mean, obviously, the Fed is watching all the same data that you and your colleagues are watching. What's your prediction on when you could see tapering, and when you could actually start to see rates move?
- Right. I think the bar to announce tapering very soon is low. Chair Powell pretty much told us in the last press conference that we didn't need a blockbuster labor report. Well, we didn't get a blockbuster jobs number, which means that the Fed, I think, is pretty ready to taper.
They've also given us not just the start date of taper, but also the end date of taper. Now, they have the caveat that if the economy slows down much more than they are forecasting that they could extend that. But we think actually they start tapering in November. They finish by the middle of next year.
And then the focus is all going to be on hikes, and this is where I think it's a difficult situation for the Fed, because inflation is rising. Growth is moderating. And so it's not obvious that they should be hiking, but they want to keep inflation expectations anchored.
We actually think they're going to push back. Unless there's signs of wages going up or inflation expectations spiraling out of control, we think the Fed is going to push back and say, this is still transitory inflation that they don't need to respond and push out the market timing of the hiking cycle.
So yes, they taper, but I don't think they are ready to start hiking. They do want to see signs of maximum employment, which we're very far from, before they hike. So start the exit, but it's going to be a slow, patient exit from the Fed standpoint.
- Priya, I've only got about 30 seconds. But just to make everything a little more volatile, to throw one more thing in the mix, of course, is the debt ceiling. We did get a short term push it down the road a little bit reprieve, I will say, debt ceiling. How do you expect this to play out?
- There's going to be another showdown, unfortunately, in the next few months. I think there's two ways out. The Democrats either do this themselves-- and that's why I'm watching what's happening in Washington around the partisan reconciliation plan. Hopefully, they can come in on the big ask, as we call it, between 1 and 1/2 that the moderates want and 3 and 1/2 trillion that the progressives want.
They need to bridge that gap. And if they were to come up with a number, they can actually pass the debt ceiling through the Democrat-only channel. Or they can work with the Republicans, but I think that's much harder. They'll have to put spending cuts, sequester a lot more in there. So yeah, we just kicked the can down, and in a couple of months, we're going to have-- they're going to have to deal with the debt ceiling for a longer time period.
Our view is that the Democrats will do this alone. It's going to be much harder to get on board with the Republican plan. But watch what's happening on the partisan infrastructure plan first. If they can get agreement on that, I think the debt ceiling would be folded in, so next few months.
- Never a dull moment, Priya. Thanks so much.