Stock market plunges may spell trouble

Is stagflation coming? Who knows.

February 24, 2022

After a historic bull run, financial markets are off to a rocky start in 2022. The Standard and Poor’s 500 (S&P 500) and NASDAQ 100 are down approximately 8.7% and 14%, respectively, on the year. The Bureau of Labor Statistics (BLS) latest report revealed that January prices were 7.5% higher than a year ago. From restaurant meals to used cars, consumer prices are rising at the fastest pace in 40 years.

With target inflation of 2.0% year-over-year, the Federal Reserve plans to increase interest rates starting in March by an anticipated 25-or-50 basis points (one basis point equals 0.01%). While the Federal Reserve has not lifted rates in three years, they hope to drive down inflation by disincentivizing borrowing and incentivizing savings in order to cool off the economy. However, many economists worry that hiking interest rates will do more harm than good.

The global pandemic has disrupted supply chains globally. Consequently, consumers are paying higher prices for goods due to increased input costs for producers and reduced supply. Unfortunately, raising rates will not solve these issues. Instead, the action by the Federal Reserve may slow the economy and stunt economic growth while high inflation persists.

Beyond the issue of high inflation, alarms have been ringing on Wall Street because of the narrowing spread between 10-year and two-year treasury bonds. Recently, the difference in yield has dropped to a concerning level of less than 50 basis points. Ultimately, we may be headed towards an inverted yield curve or negative spread, which has preceded every American recession.

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