Our stagflation monitor

It is just over a month since the Russia-Ukraine conflict began with no immediate resolution in sight. The current stalemate suggests the likelihood of a prolonged crisis. Consequently, we think there will be further waves of sanctions imposed by the US and Western countries on Russia which in turn will increase the commodity supply-side risks further.

Apart from being a major oil exporter, Russia is also a major supplier of food, fertilisers, and materials. Sanctions on these products will also cause further supply-side shocks in other industries. Overall indices of commodity prices are approximately 29% higher since the start of the year.1 Already the lack of immediate alternative for Russian energy has seen energy inflationary pressures mounting which will impact consumer spending and slow global growth.

Adding to these woes are the persistent supply chain disruptions due to China’s latest COVID outbreak and the hawkish stance of the US Federal Reserve and other major central banks. It is no surprise that stagflation fears are increasing.

According to the Eastspring Portfolio Advisors (EPA) team, during the 1970s stagflationary period, US economic activity, measured by the ISM manufacturing index, fell below its average trend, and coincided with an inflation rate that was above its trend. Currently the ISM index is trending downwards, and the team is monitoring to see if it breaks the trend as inflation has already ticked up.  In the current situation, the likelihood of policy missteps is high. The Fed and other central banks must walk a tight rope so as not to end up tightening policy into a slowing growth environment. 

Given that sanctions will create uncertainty and volatility, the team remains neutral on equities, but will look for opportunities to increase exposure to Emerging Markets as policy shifts seem more supportive in China.  On bonds, the team has a neutral view on rates as US Treasuries historically have been reliable “safe haven” assets during periods of high uncertainty; however, there is uncertainty over the effectiveness of US Treasuries as a recession hedge amid a rising commodity price / high inflation backdrop. Gold and inflation-linked bonds look attractive at this point in time. 

US manufacturing activity vs US inflation

US manufacturing activity vs US inflation

Source: Refinitiv Datastream, Eastspring Investments, IBES, MSCI, March 2022

1 The Bloomberg Commodity Spot Index as of 28 March 2022

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