Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / The Wage-Price Spiral Myth in Modern Stagflation
Transcript
- Lucas: If you look at the CPI reading from September, it hit three hundred thirty-six point three, but what really catches my eye is the disconnect with nominal GDP. We are seeing prices rise while real output barely budges, sitting at just two point two percent annualized growth. It feels like we are living through a textbook definition of stagflation, yet the mechanics feel wrong compared to the seventies. Luna: Right, because back then, every price hike triggered an immediate wage demand to catch up. Today, workers seem to be absorbing the pain without forcing the next round of increases. Is the feedback loop actually broken, or is it just paused? Lucas: I think it’s structural. Look at the average hourly earnings for private industry; they ticked up only slightly to thirty-seven point eight dollars. That is not enough momentum to drive a true spiral. Meanwhile, job openings have dropped to seven thousand seventy-nine thousand, signaling that labor demand is cooling faster than supply. Luna: So if employers aren't fighting as hard for talent, they can't pass on those massive wage hikes to consumers. But wait, isn't the core PCE still climbing? How do you reconcile that with falling job openings? Lucas: That is the million-dollar question. Core PCE is at one hundred thirty point five, which means underlying inflation is stubbornly persistent. But persistence does not equal acceleration. In the seventies, inertia was driven by indexed contracts and union power. Today, we have fragmented bargaining and a service sector that is pricing based on capacity, not just cost-plus. Luna: Exactly. And look at the housing market headlines warning signs are flashing right now. If rents stop rising, that single largest component of the basket stabilizes, doesn't it? Lucas: It should, but the lag effect is brutal. The Fed is hiking rates into a environment where the VIX is volatile and the S&P is down half a percent over the last five days. They are trying to crush demand before the wage genie gets fully out of the bottle, but the bottle might already be empty. Luna: So we are seeing a deflationary pressure from the labor side clashing with sticky services inflation. What happens when the unemployment rate hits four point three or four point four? Lucas: Then we likely see the final nail in the coffin for aggressive hikes. The market data shows gold dropping three percent, which suggests investors are betting on a soft landing rather than a crash. They think the economy will just... drift. Luna: Drift sounds dangerous for anyone relying on steady income growth. But let's pause here for a second. If walking through these economic nuances with us has made something click, or if you value having a show that doesn't interrupt your commute with ads, you can support that choice directly. The link is buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. It keeps the research deep and the feed clean. Lucas: Thanks for keeping the lights on. Now, back to the data, because there is another layer here regarding productivity. You mentioned the service sector earlier, but are they actually producing more per hour? Luna: That is the key. If productivity is flat, then even small wage gains become expensive for businesses, leading to higher prices. But if AI or automation is boosting output quietly, that masks the inflationary pressure. What does the data say about productivity per worker? Lucas: It is murky. Real GDP grew by about thirteen billion dollars in chained twenty-seventeen dollars terms last quarter, but payrolls only added twenty-nine thousand jobs. On paper, that looks like a productivity boom, but initial jobless claims are near historic lows, meaning people are just staying employed rather than being replaced by machines. Luna: So it is labor hoarding again, but without the wage explosion. Companies are keeping staff to avoid rehiring costs, which suppresses turnover but also suppresses wage growth. Does that mean inflation stays low because firms are protecting their margins by not raising prices aggressively? Lucas: Not exactly. They are raising prices slowly, incrementally. It is a slow bleed rather than a shock. Think about the auto industry headlines from Wednesday. Buyers are demanding lower prices and better tech, forcing automakers to compress margins instead of passing costs to buyers. Luna: That is a fascinating pivot. Usually, automakers would just raise the MSRP. If they are eating the cost, it means consumer confidence is brittle. Are we seeing this in other durable goods sectors? Lucas: Yes, especially in retail. When you look at the ten-year breakeven inflation rate sitting flat at two point three four percent, it tells us that long-term expectations are anchored. People expect the Fed to eventually win, so they aren't panic-buying or demanding wild raises. Luna: But anchoring is fragile. If energy prices spike again, or if the UK inflation jump to three point five percent triggers a global ripple, won't that reset expectations quickly? Lucas: It could. Energy is tricky because gold and silver are both down nearly six percent over the week, suggesting a risk-off sentiment that usually dampens commodity demand. But if geopolitical tensions flare, the supply chain shocks we discussed in previous episodes could return. The difference now is that inventory levels are being managed differently. Luna: Just-in-case inventory versus just-in-time. Companies are holding more stock to buffer against shocks, which costs money. Who is paying for that storage and financing? Lucas: Borrowers. With interest rates still relatively high, carrying inventory is expensive. This forces companies to either raise prices or shrink margins. Since consumers are price-sensitive, as we saw with autos, many are choosing the latter. That squeeze on corporate profits is the hidden brake on the economy. Luna: So profit margin compression is the new inflation control mechanism. That is a pretty radical shift from the old model where shareholders always got their cut. Are smaller businesses feeling this pinch harder than big tech? Lucas: Absolutely. The Russell twenty fifty is up half a percent while the Nasdaq is down a percent. Small caps are resilient because they are closer to the consumer pulse, but they lack the pricing power of giants like Microsoft or Apple. They are getting squeezed from both sides. Luna: Which brings us back to the Fed. If profits are shrinking and unemployment is creeping up, will they pause the hikes sooner than expected? Or do they need to see more evidence that the spiral is truly dead? Lucas: They need to see consistency. One good month of CPI doesn't cut it. They need to see core PCE trending down while the labor market cools gradually. If they move too fast, they crash the system. If they move too slow, they lose credibility. It is a tightrope walk over a very deep canyon. Luna: And the canyon is widening every time a new data point comes out. With jobless claims so low, it feels like the labor market is hiding its weaknesses. What happens when the layoffs actually start? Lucas: That is the cliff edge. When the first wave hits, it will likely be concentrated in tech and finance, sectors that have been overhiring. Once that starts, the psychological shift in consumer spending will be immediate. People stop buying houses and cars when they fear job loss, regardless of what the headline unemployment number says. Luna: So the lag between employment and consumption is shorter than we think. We are essentially watching a delayed reaction movie where the plot twist hasn't happened yet. Do you think the current level of debt servicing costs will accelerate that twist? Lucas: It is already happening. Credit card delinquencies are ticking up, and auto loan defaults are rising among subprime borrowers. The household balance sheet is under stress, even if the GDP numbers look stable. Stability is an illusion when the foundation is cracking. Luna: Illusion or reality depends on who you ask. For the average worker, the illusion is that prices will keep coming down. For the investor, the illusion is that the market can ignore the fundamentals forever. Where do you see the break occurring first? Lucas: I see it in the bond market. If the ten-year yield spikes because investors realize inflation is stickier than the Fed admits, equities get punished hard. But if yields stay flat, we get a slow grind down in asset prices as earnings disappoint. Either way, the easy money era is over. Luna: A slow grind down feels less dramatic than a crash, but it is more exhausting for everyone involved. It requires patience and discipline that most portfolios don't have. How do we prepare for that kind of environment? Lucas: By focusing on cash flow and quality. Companies that can maintain margins without raising prices, or that can pass them on without losing volume, will survive. The rest will consolidate or fail. It is a selection event for the broader economy. Luna: Selection events are painful but necessary for long-term health. It reminds me of the post-dot-com cleanup, but with higher stakes due to the debt load. Do you think we will see more mergers and acquisitions to consolidate this mess? Lucas: Mergers and acquisitions activity is likely to pick up as weaker players get acquired by stronger ones at discounted valuations. It is a way to achieve scale in a shrinking pie. We might see some big deals announced in the next quarter as boards realize they cannot stand alone. Luna: Consolidation as a survival strategy. It is a pragmatic approach, even if it reduces competition. Does that help or hurt the consumer in the long run? Lucas: It hurts the consumer in the short term because prices may rise as merged entities gain pricing power. But in the long term, efficiency gains could stabilize costs. However, given the current regulatory climate, those efficiencies might be slower to materialize. Luna: Slower efficiencies mean prolonged pressure. It seems like we are trading speed for stability, but at what cost to growth? Is two percent growth the new ceiling for this cycle? Lucas: Two percent might be the floor, not the ceiling, if productivity picks up. But until we see a genuine surge in innovation-driven output, we are likely stuck in this neutral zone. It is not a crisis, but it is not a recovery either. Luna: A neutral zone where nothing moves fast enough to fix anything. It feels like the economy is holding its breath. What happens when it finally exhales? Lucas: When it exhales, it will probably be with a correction. The buildup of imbalances cannot continue indefinitely. The question is whether that correction is managed gracefully or if it turns into a disorderly unwind. Luna: Disorderly unwinds are rarely graceful. But if we have learned anything from the past decade, it is that markets adapt in ways we never predict. Maybe the solution is already emerging in the shadows. Lucas: Maybe. Or maybe we are just staring at the same old problems with new labels. The wage-price spiral may be dormant, but the underlying tensions between cost and revenue are still there, waiting for the right trigger. Luna: Waiting for a trigger that could come from anywhere. A geopolitical shock, a policy error, or just a sudden shift in consumer sentiment. It makes planning incredibly difficult. Lucas: It does. But understanding the mechanics, like we did today, helps you see the signals before they become headlines. Knowing that the spiral is broken changes how you view every CPI release. Luna: And knowing that profit margins are the new brake pedal explains why the market is reacting the way it is. It connects the dots between the Fed, the worker, and the wallet. Lucas: Exactly. The narrative is shifting from inflation dominance to margin compression. It is a subtle but critical change in the economic landscape. Luna: A subtle shift with massive implications. If you follow that thread, you might just spot the turning point before everyone else does. Lucas: Or you might find yourself chasing a ghost. The economy is full of ghosts, Luna. The trick is knowing which one is real. Luna: Here's to hoping the real ones give us a clear path forward, rather than just another mystery to solve.