Is The Economy Entering Stagflation?

Stagflation Fears Not Valid Yet

The two top stories of the day on Wednesday were the retail sales report and the CPI report. The combination of a weak consumer and heightened inflation brings about the fear of stagflation which is a stagnant economy and high inflation. This is probably an extreme worry because we’re far from reaching that state. Two weak retail sales reports don’t mean the economy is weak and a few inflation reports that beat estimates doesn’t mean inflation is getting out of control. In fact, economists were begging for inflation last year. It’s only a few tenths of a percent higher than last year.

I think stocks recognized that the situation isn’t as dire as some fear because it was up nicely. The S&P 500 was up 1.34% and the Nasdaq was up 1.86%. Chipotle stock was the biggest winner as it was up 15.4%. It did well because the company named a new CEO on Tuesday evening. The company is still trying to get passed its woes that came from health issues at the restaurants. The best sector of the day was the financials which was up 2.32%. The worst sector was the utilities which was down 1.19%. This is purely a play on yields as the financials are helped by higher yields because of the increase in their net interest margins. The utilities are hurt because higher yields provide more competition for investment as the utilities are mainly owned because of their high dividend yields.

The 10 year yield closed at 2.90%. It is only 10 basis points away from the peak in 2014. Since I think the economy will be stronger this year and because it is later in the cycle, I wouldn’t be surprised to see yields eventually pass 3%. In the near term treasuries are very oversold though. The increasing yields are driven by increases in real yields and the breakeven inflation rate which is now at 2.07%. It’s still below the high it made at the beginning of the stock market correction in early February.