Dive Brief:

• The U.S. faces a risk of long-term stagflation, or near-zero economic growth along with persistently high inflation — an outcome especially harmful to companies that are vulnerable to rising raw materials prices or a slump in “discretionary demand,” according to Moody’s Investors Service.
• “The potential for a long-lasting stagflationary environment remains a concern that will persist until the current bout of inflation firmly subsides,” Moody’s said. The odds of recession during the next 12 months are 59.5%, Moody’s Analytics said in a separate report.
• A stagflationary economy would feature an unmooring of inflation expectations, “a much more aggressive” withdrawal of monetary stimulus and persistently weak economic growth, Moody’s said. High energy costs would hit earnings in sectors such as airlines, autos, chemicals, metals, forest products and shipping, while rising materials costs would harm construction and manufacturing companies.

Dive Insight:

Concerns about a return of 1970s-style stagflation have risen as economic growth slows and price pressures remain high despite the most aggressive withdrawal of stimulus by the Federal Reserve since the 1980s. The murkier outlook has compelled many CFOs to redraw their plans for prices, borrowing and wages.

The economy will probably not grow this year, Fannie Mae said on Wednesday. Next year, high inflation, Fed tightening and a slump in the housing market will probably push down gross domestic product by 0.5%.

The Conference Board, citing the reduction in Fed stimulus, predicted this month that the economy will tip into a brief, shallow recession from the fourth quarter through the first quarter of 2023.

The economy may already be in a contraction. It shrank 0.6% during the second quarter after slumping 1.6% during the first three months of 2022, meeting the common definition of a recession as at least two consecutive quarters of negative growth.

“Though the U.S. economic data have been decent, the economy is still at risk,” according to Moody’s Analytics. The economy “is vulnerable to anything going wrong, including further tightening in financial market conditions or an unexpected hike in energy prices.”

Pessimism about the economy is far from universal. The Organization for Economic Cooperation and Development on Monday forecast that the U.S. economy will grow 1.5% this year and 0.5% in 2023. Yet its estimates are 1 percentage point and 0.7 percentage point less than OECD forecasts in June, respectively.

Fed officials on Wednesday also trimmed their expectations for economic growth. They forecast a gross domestic product gain of just 0.2% this year, down from a June estimate of 1.7%. For next year, they predict 1.2% growth compared with a 1.7% forecast in June.

“The Fed is clear it will not countenance stagflation and will aggressively tighten monetary policy to force the economy into recession to wring out the high inflation and inflation expectations,” Moody’s Chief Economist Mark Zandi said in a report.

The central bank Wednesday intensified its fight against the highest inflation in nearly four decades, raising the benchmark interest rate by 75 basis points for the third straight meeting and pushing up estimates for further increases in borrowing costs through next year.

Policymakers lifted the target range for the federal funds rate to a range between 3% and 3.25%. The median projection showed that they expect to lift the rate to 4.4% by the end of 2022 – a full percentage point above their June estimate – and to 4.6% by the end of next year.

The surge in consumer prices slowed last month to 8.3%, but the decline from 8.5% in July was less than forecast and well above the central bank’s 2% inflation target.

Shelter, food and medical care costs rose, driving much of the increase in the Consumer Price Index (CPI), the Labor Department said Sept. 20.

“Whether the economy suffers a downturn or skirts one depends on if inflation continues to steadily moderate back to the Fed’s target,” Zandi said.