ESTAGFLAÇÃO À PORTA

Global Stagflation Ahead? The Interplay of Aggregate Demand and Aggregate Supply Shocks
Nouriel Roubini

The recent rapid rise in commodity prices – oil, energy, metals and agricultural commodities – is leading to the concern that the ensuing rise in global inflation may be associated with a slowdown of global economic growth if not an outright global recession; i.e. there are rising worries about stagflation, a deadly combination of rising inflation and economic recession.
Indeed, not only inflation is rising in many advanced economies and emerging market economies but there are signs of a likely economic contraction in many advanced economies (the US, UK, Spain, Ireland, Italy, Portugal, Japan). In emerging market economies the rise in inflation has been associated so far with rapid economic growth and economic overheating; but there are worries that the economic contraction in the US and other advanced economies may lead to a growth recoupling – rather than decoupling – in emerging markets at the time when rising inflation is forcing monetary authorities to tighten monetary and credit policies to control rising inflation; so “stagflation lite”, i.e. rising inflation cum sharply slowing growth may soon become a problem also for emerging market economies. So should we worry about stagflation or “stagflation lite”?

Oil price volatility made a new mark last week with WTI crude oil futures for July delivery spiking $16 in 2 days to new all-time highs: $138/barrel close, $139/barrel intraday. The $10 spike on June 6 alone was the largest one-day advance in the history of oil futures since trading commenced 1983. Oil-induced inflation fears are rocking the stock markets – DJIA dropped 395 points on June 6, the largest drop in 15 months – and making central banks lean towards a monetary hike. And in spite of the modest retrenchment in oil prices this week from last Friday’s peaks, such prices remain extremely high in nominal terms and higher than any time in the past in real terms. Hoarding and speculation in commodities have delayed the commodity inflation slowdown predicted to arrive on the coat-tails of the U.S.-led global growth slowdown. The resulting decline in demand should contribute to crimp the rally in commodities and stave off stagflation - barring an Israeli attack on Iran that would induce a supply-side shock to oil markets. However, lower commodity prices have yet to follow falling oil demand and the word “stagflation” is on everyone’s lips. The sustained rise in the oil price since 2002 created a windfall for oil exporting nations. With much of the revenues saved, the surpluses of oil exporting economies contributed to existing global imbalances. China’s record 2007 trade surplus was recorded despite the rising cost of its oil imports. While many oil exporting economies are now spending more, much more is now being saved and thus invested in foreign assets. $130 barrel oil or more will increase the surpluses of oil exporting economies, particularly as high inflation at home limits further domestic spending growth, and increase the corresponding deficits in oil importing economies. Globally, the imbalances are shifting somewhat, with Europe’s previously small deficit now rising. Yet with oil exporters reluctant to allow appreciation against the USD, much of the windfall may still take the form of recycled petro-dollars. (...) Although the high price of oil is, as expected, eroding demand, it is doing that very slowly. Chinese demand shows little signs of abating, even if some of the high-powered demand from other Asian countries could diminish as prices rise on the reduction or removal of subsidies which became far too costly for the fiscal position of their governments. Yesterday the IEA again downgraded its forecast for global consumption – but it still expects demand to rise from 2007 levels and forecasts little new supply, suggesting that high oil prices were needed to erode demand and bring the market back into balance. (...) Due to downward revision to expected economic growth, Asian central banks kept loose monetary policies to support exports and domestic demand. However, negative real interest rates coupled with food and oil price shocks have raised inflation to record levels, while recent fuel price hike in some countries has only exacerbated this effect. Inflation risk is now reflected in equity market corrections and currency depreciation (in some countries) as foreign investors remain alarmed. Though some Central Banks have geared up to raise interest rates, Asia may already be at the verge of slowing growth and upward spiraling inflation. (...) Despite monetary tightening and removal of subsidies in emerging markets, global monetary policy remains expansionary. G7 central banks have largely remained on hold, hemmed in by slowing output, rising unemployment, and higher inflation. Even after the sell-off in safe haven government bonds since March 17, real interest rates in the U.S., as reflected by Treasury yields, remain low or negative. With the 2-year German Bund yielding nearly twice as much as its U.S. counterpart and the ECB signaling a possible rate hike in July, the USD is experiencing significant downside risk versus the EUR, especially if the recent hawkish rhetoric by the Fed remains rhetorical. (...). The outlook for long-term government bond yield – while varied depending on which country one considers – is driven by several factors pulling in different directions: an increase in global savings driven by higher oil price windfall that is saved would reduce real interest rates as it increases the “global savings glut”; rising oil and commodity prices feeding into inflation expectations would lead to higher nominal rates; monetary policy tightening may lead to higher real rates but – if successful in controlling inflation expectations – it would tend to lower nominal real rates; continued flight to safety – if financial markets turmoil persist – would lead to lower nominal and real rates; and a US economic contraction and global recoupling larger than currently priced by markets would tend to lead to lower real and nominal bond yields. Thus, bond yields are being buffeted by very different and opposite forces. Low U.S. interest rates are a disincentive for oil producers to extract oil now when most of the proceeds will be invested in such low-yielding assets as Treasuries. And, as long as oil producers plow most of their oil windfall into Treasuries and yields stay lower than they're expected to be in the future, oil supply growth could remain historically low – supporting high oil prices. (...) At the same time, low Treasury yields up the ante for oil producers to allocate more of their savings towards non-dollar assets or at least buy more non-dollar assets to maintain a constant ratio of USD-assets to non-USD assets. Either case poses further downside for the dollar. (...) In turn, a weaker dollar may beget stronger oil prices. Unfortunately for oil consumers and inflation hedgers, U.S. bond yields are guided by factors other than inflation - such as a flight to safety from credit crisis or stock market turmoil. Not even TIPS guarantee inflation-protected returns as TIPS yields are indexed to U.S. CPI figures which might very well understate actual inflation. (...)