Stagflation(ish)

Episode Summary

Executive Summary: The episode argues that the U.S. is not in stagflation today, but is moving toward a stagflationary setup through tariffs, restrictive immigration policy, and rising geopolitical/energy risks. Speakers explain why May CPI/PPI stayed tame, why tariff pass-through may be delayed, and why the Fed is trapped between softer growth and potentially higher inflation.

Main Topics: Defining stagflation and why it matters (Priority: 5/5): Chris explains stagflation as the combination of stagnant growth, high unemployment, and high inflation, noting that inflation expectations make it especially hard to escape and that the Fed would likely need to induce a recession to break it. Why May inflation data looked benign (Priority: 5/5): Matt says CPI and PPI were subdued in May, with no clear tariff pass-through yet. He attributes this to front-loaded imports, inventory drawdown, business margin absorption, and softer demand in some categories like air travel. Tariffs as a stagflationary supply shock (Priority: 5/5): The group discusses how higher effective tariffs should raise inflation and reduce GDP growth over time, but argues the transmission is delayed because firms are using pre-tariff inventory and hoping policy is temporary. Immigration restrictions and labor supply (Priority: 4/5): Marissa argues that tighter immigration policy and deportations reduce labor supply, especially in construction, hospitality, agriculture, and healthcare, which pushes up wages and constrains output, especially in housing. Geopolitical shock and oil prices (Priority: 5/5): The Israeli strikes on Iranian facilities and the resulting rise in oil prices are presented as a fresh inflation and growth risk, with special emphasis on gasoline, diesel, food prices, and household expectations. Fed policy dilemma and recession risk (Priority: 4/5): The panel says the Fed would not welcome a wage-price spiral and may prefer to keep rates restrictive. The speakers give recession probabilities ranging from 45% to 66% over the next 12 months, reflecting rising downside risk.

Key Arguments: Stagflation requires both weak growth and high inflation, plus entrenched expectations; the current economy is only 'stagflation-esque,' not classic 1970s-style stagflation. May CPI/PPI did not yet show major tariff pass-through because businesses front-loaded imports, are drawing down inventory, and are temporarily absorbing costs in margins. Tariffs can raise inflation roughly 10 bps for every 1 percentage point increase in the effective tariff rate and reduce GDP growth by roughly 7-8 bps in the following year. Restrictive immigration policy reduces labor supply, which lifts wages in immigrant-intensive sectors and constrains housing and other output, adding inflation pressure. Higher oil prices are especially dangerous because they directly affect gasoline, diesel, food, and consumer inflation expectations, and they can weaken real purchasing power. The Fed is unlikely to tolerate a sustained wage-price spiral; if stagflation truly took hold, policy would likely turn more restrictive, even at the cost of recession. Business optimism that tariffs will be rolled back helps explain weak pass-through so far, but the panel expects eventual price increases if tariffs remain elevated. Current strong business balance sheets and high margins give firms some ability to absorb shocks temporarily, but that cushion is limited.

Data Points: CPI (May, monthly headline): 0.1% - Matt said consumer prices were very subdued in May. CPI (May, monthly core): 0.1% - Core CPI also came in extremely tame. PPI (May): below expectations - Producer prices also did not show meaningful tariff pass-through. Current core PCE inflation: 2.5% year over year - Referenced as the baseline rate before tariff effects. Effective tariff rate (current assumption): 15% - The team’s working estimate for the current effective tariff rate. Effective tariff rate before tariffs: 2% - Used as the pre-shock comparison point. Tariff-to-inflation rule of thumb: 10 bps inflation per 1 ppt tariff increase - Applied to estimate the inflation impact of higher tariffs. Estimated tariff effect on inflation: about +1.3 percentage points - Derived from a rise in effective tariffs from 2% to 15%. Estimated core PCE a year from now: 3.5% to 4.0% - Forecast range discussed after incorporating tariff effects. Tariff-to-GDP rule of thumb: 7-8 bps lower GDP per 1 ppt tariff increase - Used to estimate weaker growth from higher tariffs. Oil market context: 2-3 million barrels/day from Iran - Rough estimate of Iranian exports discussed as a meaningful supply risk. Global oil consumption: about 100 million barrels/day - Used to frame Iran’s share of global supply. NFIB businesses planning price increases: 31% - Highest in about 15-16 months, signaling ongoing pricing pressure. Prior NFIB reading: 28% - The earlier level before the latest increase. CPI imputed/geographically estimated components: 30% - Matt said about 30% of CPI components were imputed in May. Earlier typical imputation share: 10-12% - Used to show how unusual the current measurement problem is. Foreign-born labor force growth: negative recently - Mark said foreign-born labor force growth turned negative after previously running 4-5%. Potential recession probability: 45% to 66% - Panel estimates ranged from 45% (Marissa) to 66% (Matt), with Mark at 48% and Chris at 50%. Expected inflation one year ahead (panel views): about 3.0% to 3.5%+ - Marissa said 3%; Mark said 3.5%; Matt was less specific but viewed inflation as elevated. Gold share of official foreign reserve assets: 19.1% - Chris cited ECB data showing gold rising to second place globally among reserve assets. Dollar share of foreign reserve assets: 47% - Used to illustrate continued dollar dominance despite erosion.

Pivotal Quotes: "At its core, stagflation is a situation where you have stagnant economic growth, high unemployment, and high inflation." — Chris: Chris gives the basic definition of stagflation early in the discussion. "The expectation is that these policies aren't going to be here." — Matt: Matt explains why businesses and markets may be delaying tariff pass-through and why equities recovered. "If we go into a recession in the next year, I don't think it's going to be that high." — Marissa: Marissa notes that recession would likely cap inflation even if current risks are rising.

Implications: Listeners should expect higher inflation risk to build with a lag, especially if tariffs, immigration restrictions, and oil shocks persist. The Fed may stay cautious, while recession odds rise and data quality problems make inflation harder to read.