What happened to the economic recovery? The economy is supposed to be creating more jobs than are being revealed in the monthly nonfarm payroll reports. The fact is that this recovery has produced less job creation than past recoveries, but the numbers may not be as bad as they seem. According to the household survey, the economy has created 600,000 jobs. This survey takes into account folks going into business for themselves.
All well and good, but the nonfarm report weakness has caused some to question what's going on with growth and whether it may soon stall out. It's a confusing time because while the jobs numbers are weak, the capacity and productivity reports say things are going very well.
What about inflation? The moderate rise we've had so far has been a good thing, but let's hope it doesn't grow to the point where it becomes stifling. The Fed hasn't taken a stance on what defines too much inflation, but it'll know too much when it sees it, hopefully. At this point, though, the uptick in inflation is consistent with economic recovery.
On Aug. 10, the Fed raised rates another quarter of a point, as expected. The Fed is not done raising rates, in my opinion. Some market watchers are concerned that growth will slow but that inflation will still go up. This may lead to a nasty combination of economic stagnation and inflation called stagflation, a term many last heard in the 1970s.
Stagflation is an economic headache because there isn't supposed to be increasing inflation when an economy is slowing down. But if inflation does rise during a slowdown, the Fed would likely have to curb it with rate increases. While that may be necessary, it could further retard economic growth -- remember, the Fed usually likes to lower rates to stimulate borrowing (and the economy) in soft times.
Another way to think of things is that accelerating inflation alone is usually thought of as a negative for the stock market. And rising rates, alone, are also considered to be negative for the stock market. Combined, they could create a compounded negative environment for equities.
The stock market, it could be argued, reflects investors' views of the economy's future. Over the last few months it has sold off. This could be from oil, Iraq, the election, or something else. I'd be surprised if the stock market were pricing in a recession, but who knows? At a minimum, it makes sense to be in touch with what can go wrong. While stagflation is unlikely, I'm concerned about the number of commentaries I have read saying it can't happen. I am always wary of consensus thinking.
This can be as complicated as you want to make it, but the take-away is that slowing growth and rising interest rates make a bad combination.
Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz.
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