Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / How Energy Shocks Create Stagflation
Transcript
- Lucas: The most dangerous kind of inflation isn't the one where everyone gets rich, it's the one where the economy grinds to a halt but your grocery bill keeps climbing. That is the definition of stagflation, and right now, with October fifteenth approaching, the signals are getting harder to ignore. Luna: Right, and it feels less like a temporary blip and more like a structural shift in how energy and goods interact with our wallets. Lucas: Exactly. We need to stop treating inflation as just a monetary phenomenon and start looking at it as an energy problem. When you look at the latest CPI reading of three hundred thirty-four point one, and the core CPI sitting at three hundred thirty-seven point eight, you are seeing the residual heat from supply shocks that never fully dissipated. Luna: So you are saying the stickiness here isn't about wages, but about the cost of moving things? Lucas: Precisely. The thing is, energy is the input for everything. If fuel costs go up, shipping costs go up, manufacturing costs go up, and those costs get passed down the line. It creates a feedback loop that makes disinflation incredibly difficult because you cannot simply print your way out of higher energy bills. Luna: But doesn't higher energy usually signal strong demand? Why would it slow growth if people are still buying? Lucas: That is the trap. In a normal boom, high demand drives prices up, but it also drives production and hiring. In stagflation, the energy shock acts as a tax on consumption. You see it in the real GDP growth number, which has slowed to two point two percent annualized for the second quarter. The engine is still running, but it is losing power. Luna: And yet, unemployment is holding steady at four point two percent, so businesses aren't firing en masse yet. Lucas: They are not firing, but they are not hiring aggressively either. Job openings have dropped to seven thousand seventy-nine thousand, down from earlier peaks. Companies are absorbing the higher energy costs by cutting back on expansion rather than laying off workers immediately. It is a slow bleed. Luna: It sounds like a liquidity squeeze disguised as a growth problem. Lucas: It is exactly that. And this brings us to the commodities market, which is screaming about where the world thinks energy and value are heading. Look at gold. Spot gold is trading around four thousand one hundred eighty-eight dollars per ounce, and the gold miners ETF is up over two percent in the last five days. Luna: That is a significant move for such a large asset class. Investors are clearly nervous about the purchasing power of fiat currency. Lucas: Nervous is putting it mildly. They are pricing in a scenario where central banks are trapped. If they raise rates to kill inflation, they crush the fragile growth we have left. If they cut rates to support growth, they let inflation run wild. It is a lose-lose situation for policymakers. Luna: So the VIX stays elevated, and money flows into hard assets like gold and silver instead of productive equities. Lucas: Silver is also up, trading near fifty-nine dollars, which often leads gold in these speculative bursts. But the real story is the ten-year breakeven inflation rate. It has ticked down slightly to two point three three percent, but that is misleading. The market is betting that inflation will be lower in the long term, not that it is low right now. Luna: Because they think a recession will eventually force prices down, even if the pain is severe? Lucas: Yes. The breakeven rate reflects expectations of future deflationary pressure from a downturn. But until that downturn hits, we are stuck in this limbo. The IMF recently warned about disorderly spikes in bond yields, which is another way of saying debt servicing costs are becoming unmanageable for governments already dealing with high inflation. Luna: It is interesting how AI investment is supposed to offset this. Does productivity actually help when energy costs are the bottleneck? Lucas: That is the critical question. AI can improve efficiency, but it requires massive amounts of electricity. If energy prices remain high, the capital expenditure required for AI becomes even more burdensome. We saw real GDP growth slow from two point five percent to two point two percent. The tech sector might be booming, but the broader economy is feeling the pinch. Luna: So the stock market rally is narrow, driven by a few giants who can absorb the costs, while the rest of the S&P 500 struggles. Lucas: Look at the Nasdaq. It is down one point two percent over the last five days, while the Dow is up one percent. Money is rotating out of growth stocks and into value and defensive sectors. Investors are fleeing risk. The Russell twenty hundred is essentially flat, showing that small caps, which are most sensitive to borrowing costs, are being squeezed. Luna: Small caps are getting crushed between high loan rates and their inability to pass on energy costs efficiently. Lucas: Exactly. They do not have the scale to hedge against commodity prices. When you combine stagnant growth with rising input costs, margins get compressed. That is classic stagflationary pressure. It is not just about prices going up; it is about profits going down. Luna: And that leads to less investment, which leads to slower innovation, which makes the productivity argument even weaker. Lucas: Right. The vicious cycle. Now, I want to pause for a second here. If walking through the economy with us has made something click, or if you feel like we are helping you navigate this noisy market, the way these stay ad-free is listener support. You can buy me a coffee dot com slash fexingo. Luna: It really does make a difference in keeping the research deep and the commentary sharp, so we appreciate any support you can give. Lucas: Thank you. Now, back to the data. Let's look at the labor market more closely. Average hourly earnings for private workers are at thirty-seven point eight dollars, up slightly from thirty-seven point seven six. Wage growth is positive, but is it enough to keep up with inflation? Luna: Probably not. If inflation is sticking around three percent, wage growth needs to be higher to maintain real purchasing power. Lucas: Correct. Real wages are effectively stagnant. Consumers are feeling poorer because their income is not keeping pace with the cost of living. This suppresses discretionary spending, which hurts retail and service sectors. It is a demand-side problem created by a supply-side shock. Luna: So the central bank is fighting a war on two fronts: rising prices and falling demand. Lucas: A war on two fronts where every move they make helps one side and hurts the other. If they hold rates high, unemployment rises. If they cut, inflation rebounds. It is a delicate balancing act that has no perfect solution. Luna: Do you think we will see a soft landing, or is a mild recession inevitable to break the inflation cycle? Lucas: I think a mild recession is the most likely path to normalization. The economy needs to cool down enough to reduce demand pressure. The jobless claims are down to one hundred ninety-seven thousand, which is good, but it masks the underlying weakness in new hires. The JOLTS data shows fewer openings. Luna: It seems like the labor market is cooling from the inside out, not with a bang but with a whimper. Lucas: A whimper is exactly what we are seeing. Nonfarm payrolls added only twenty nine thousand jobs in September, down from previous months. The momentum is fading. When you add in the energy constraints, it becomes clear that growth is structurally limited right now. Luna: So investors should prepare for volatility, not a smooth recovery. Lucas: Absolutely. The key takeaway is that energy prices are the hidden driver of this economic malaise. Until we see a sustained drop in energy costs or a breakthrough in efficiency that decouples growth from energy intensity, we will remain in this sticky inflation environment. Luna: It changes how we view every corporate earnings report too. Margins are under constant threat from input costs. Lucas: It does. And it means that traditional valuation metrics based on past earnings may be misleading. Forward-looking estimates need to account for the persistent drag of energy and supply chain frictions. Luna: So the prudent move is to focus on companies with strong pricing power and low energy dependence. Lucas: Or those that can internalize the cost, like vertical integrators. It is a complex landscape, but understanding the energy link helps clarify why the Fed is stuck and why markets are jittery. Luna: We will have to watch the next CPI release closely to see if the trend holds or accelerates. Lucas: Agreed. The data from October will tell us if we are entering a deeper slowdown or if the energy shock is finally pricing itself out of the system.