Is a Second Wave of Inflation On the Horizon? Examining the Parallels and Differences with the 1970s

Recent discourse among market strategists, including noted JPMorgan analyst Kolanovic, suggests that we could be on the cusp of a second wave of inflation, drawing unsettling similarities with the economic conditions of the 1970s. As someone closely observing these trends, I find the parallels cannot be ignored.

The 1970s were marked by high inflation that unfurled in three distinct waves, each tied to geopolitical shocks. These included conflicts in Southeast Asia, turmoil in the Middle East leading to oil embargoes and energy crises, and significant disruptions in shipping. Deficit spending rose, and the burden of interest payments on government, corporate, and personal debt weighed heavily on the economy. During this period, equity markets stagnated, and the real value of investments often eroded, while bonds and credit saw relative outperformance.

In the current economic landscape, there are indeed several similarities with the 1970s that are raising concerns about a second wave of inflation. Geopolitical tensions are escalating, affecting global trade and energy supplies, which is reminiscent of the disruptions experienced during the 1970s. The Drewry World Container Index, with its sharp rise, suggests parallels to the shipping disruptions of that era, underscoring how global supply chains are once again under significant stress.

However, while these parallels are noteworthy, we must also recognize that today’s economy is markedly different from that of the 1970s. The nature of the current inflationary pressures, the state of technology and globalization, and the responses of central banks distinguish our current situation from the past. Let’s explore why today’s inflationary environment is different:

1. Nature of Shocks: Unlike the 1970s, which were defined by prolonged and massive supply shocks like the tenfold increase in oil prices, the current inflationary pressures have been largely attributed to a temporary mismatch caused by the pandemic. As services were curtailed due to COVID-19 restrictions, there was a surge in demand for goods. This sudden change caught suppliers off guard, leading to bottlenecks and shortages. When combined with the expansive fiscal stimulus provided by governments worldwide to mitigate the economic fallout, this created upward pressure on prices.

source: thebalancemoney

2. Inflation and Growth Dynamics: Today’s economic situation differs from that of the 1970s. Back then, high inflation was accompanied by rising unemployment, but the current inflation surge is occurring alongside a significant drop in unemployment rates in both the US and the euro area. This unexpected combination has surprised many economists, who had forecasted a recession due to the increase in interest rates designed to control inflation. The current state, where we see high inflation but not high unemployment, undermines the typical expectations of a stagflation environment, which is usually marked by sluggish growth, high inflation, and rising unemployment. The resilience we’re observing in the job market, along with the economy’s unexpected adaptability, suggests that the challenges we face today may not lead to the same level of economic difficulty or the extended period of stagnation that were hallmarks of the 1970s.

3. Monetary Policy and Expectations: Central banks today have a greater understanding of the role that inflation expectations play in the inflation process. They are more proactive and have a wider range of tools at their disposal to respond to inflationary threats.

Given these significant differences, it is not as straightforward to draw direct parallels with the 1970s. While we must be vigilant about the similarities, we must also understand and respond to the unique aspects of our current economic climate.

The approach I prefer is not to draw direct parallels with past economic scenarios, such as the 1970s. Instead, my strategy relies on real-time data to gauge the inflationary environment and adjust asset allocations in response to these indicators. This approach is grounded in the belief that being responsive to the current inflation trend is more actionable and may offer a more reliable basis for decision-making.

This practical, trend-based strategy allows for tactical positioning in the market that can capitalize on longer trends. It emphasizes the importance of understanding where we are in the current cycle and adapting investment strategies accordingly. By staying attuned to the present inflation trends, investors can make informed decisions to potentially profit from the prevailing economic conditions without getting entangled in trying to predict long-term outcomes or comparing different economic eras.