Stagflation in the US
Last week, a significant number of economic indicators were released in the United States. The following points stood out:
- Inflation in the US is creeping upwards, not so much due to import tariffs, but primarily because of rising labour costs.
- Employment figures were decidedly poor. The increase in employment in July by 76,000 jobs was moderate, but the revisions for May and June were so substantial that there was hardly any growth left in those months. Nevertheless, the rise in unemployment – from 4.1% to 4.2% – was minimal. This is due to the near halt in immigration and the deportation of foreign nationals. Combined with the very limited growth in the native labour force, this results in a near stagnation in the expansion of the working population. Fed Chair Powell stated this week that to assess the state of the labour market and the economy, it is better to focus on developments in unemployment and wages rather than job growth. Still, the disappointing employment figures, after revision, point to very low economic growth.
- Washington appears to have raised import tariffs from an average of about 3% to approximately 18%.
This raises several interesting questions:
- The slow economic growth is not due to restrictive fiscal or monetary policy, but rather to the uncertainty caused by the import tariffs (see also our recent reports on this). Especially since the US economy is increasingly driven by massive investments from major tech companies.
Normally, this would have led to high growth. This situation is likely to frustrate Trump, as low growth increases the budget deficit. At the same time, he urgently needs the revenue from import tariffs to keep the deficit somewhat under control. Lower interest rates would therefore be highly beneficial: they stimulate growth and reduce the government’s interest payment burden. The big question is whether the Fed will lower rates due to the low growth. We do not expect this for now, as unemployment is too low and inflation too high. If we are correct, this could lead to a fierce conflict between the Fed and the White House.
- Who will bear the cost of the import tariffs? The exporter, the importer, or the consumer? Recent reports suggest that many exporters have started lowering their prices, and importers are finding it very difficult to pass on the tariffs to consumers in the current low-growth environment. However, surveys indicate that neither exporters nor importers intend to maintain this for long. This means that the limited rise in inflation so far says little. It is likely that in the coming quarters, more of the import tariffs will be passed on to consumers—unless economic growth drops to 0% or below, which currently does not seem likely.
- Surveys also show that companies are not inclined to relocate much of their foreign production back to the US. Import tariffs are generally seen as ultimately negative for the US economy, and it is assumed they will not last long.
- A key question is how foreign countries will respond. Most have not taken countermeasures. This could easily trigger a trade war, although they also expect the tariffs to be short-lived. Their response has been to shift focus to countries outside the US. China, meanwhile, is not overly concerned. Due to its control over rare earth materials, it currently holds a strong position relative to Europe and the US.
This brings us to the expected market reactions:
- In Europe, inflation has dropped to 2% and unemployment is very low. This means that unless the US falls into recession or the euro strengthens significantly, the ECB has little reason to further lower interest rates. The Fed will face strong pressure from the government to cut rates, but we do not expect it to comply. From this perspective, there is little reason to expect major EUR/USD exchange rate fluctuations. However, such fluctuations could still occur if foreign capital holders lose confidence in the US due to current policies (also covered in our recent GFM reports). This is something we certainly do not rule out and will continue to monitor closely in our upcoming research.
- For equities, the combination of low growth, limited room for rate cuts, and high valuations does not appear favourable.
- In our view, it is only a matter of time before this situation leads to increased demand for gold and silver.
Good weekend!
