Constructing a narrative around market and economic data is both beneficial and troublesome. Beneficial, because it helps our human minds take in data by making that data part of a story. We are generally better at understanding how stories develop, and — more importantly — how they might end. Troublesome, because narratives can capture our minds and keep us from taking in data that is contray to the story we have constructed. As investors we need to use narratives, but not hold too tightly to them.
Why does this matter? Because, right now, the economic data is difficult to parse. It has consistently given support to more than one narrative, and, just last week, the Fed highlighed yet another narrative to consider: stagflation. Stagflation is when the economy stops growing while prices keep going up. It is damaging because, typically, prices fall when economic growth stumbles and the Fed cutting interest rates leads to improved growth and higher prices. Stagflation, however, ties the hands of the central bank. They can’t spur economic growth by cutting rates because that would send prices higher, while raising rates would worsen economic growth and do little to offset prices.
Typically, stagflation is the result of a supply imablance in the economy. Enough people want certain goods and yet those goods cannot be produced and delivered efficiently, usually due to a policy that constrains businesses. Last week’s projections by the Federal Reserve suggested that they belive stagflation is now the likely narrative for the US economy. Better than recession, I suppose, but not by much.
My view is that a recession is still the most likely outcome, though any number of things could serve to reverse that. At the moment, tariff policies threaten to constrain businesses (and hence the stagflation narrative), but the Trump administration has already walked some of that back. In any event, the real issue facing the US eocnomy at the moment is employment, which has continued to worsen, and put US consumers under additional strain (see this week’s chart).
Chart of the Week
One clue that all is not well with US consumers has been the consistent increase in mortgage delinquencies. While dwarfed by the delinquencies seen in the Great Financial Crisis of 2008 – 2010, and the Covid lockdown of 2020 – 2021, delinquencies have risen by around 20%, every quarter, for the last six quarters in a row. If we assume that people pay to keep their homes first, this is a signal that peeople are experiencing quite a bit of strain, and other spending may also be under pressure.
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