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Key insights from the week that was.

In Australia, the Q1 CPI printed 1.0% (3.6%yr) for headline inflation and 1.0% (4.0%yr) for underlying trimmed mean inflation, meaningfully higher than consensus and likely the RBA’s view too, based on our assessment of its June 2024 forecast (3.3%yr headline, 3.6%yr trimmed mean). The latest update is consistent with an ongoing moderation in consumer inflation, aided in large part by global disinflationary forces within tradables, but the detail did reveal some upside surprises in the quarter.

Electricity prices were not as weak as anticipated (–1.7% vs. –3.4% forecast), though it is worth emphasising that the Government’s Energy Bill Relief Fund remains an effective tool in shielding households from much worse outcomes. Additionally, the increase in pharmaceutical prices (7.1% vs. 4.7% forecast) and financial/ insurance premiums (2.0% vs. 1.4% forecast) were stronger than expected, while car prices also surprisingly lifted (1.0% vs. –0.6%). The upside surprises were generally not in categories that point to strong domestic demand, however.

As detailed by Chief Economist Luci Ellis in her note mid-week, evidence of a slower-than-expected pace of disinflation during the opening quarter have coincided with a firmer set of data prints on the labour market over recent months. The balance of risks points to the RBA Board retaining a cautious perspective over the next few months, as new information on the labour market, prices and economic growth are closely scrutinised for signs of upside risk to the inflation outlook.

All-in-all, we still anticipate that there will be no change to the RBA’s policy stance in May; however, we now expect policy to remain on hold for longer, with the first rate cut now forecast to occur in November rather than September. Thereafter, and assuming no further upside surprises to inflation, the RBA will have scope to lessen the contractionary setting of monetary policy at an incremental and measured pace. We expect 25bps of rate cuts per quarter through to Q4 2025, to a terminal rate of 3.10%.

Also critical to the medium-term economic outlook will be developments around fiscal policy. For an in-depth analysis on the national fiscal outlook ahead of the Federal Budget update in May, see our latest update published earlier today on WestpacIQ.

Offshore, the focus was on the US activity data showcasing a resilient economy. GDP expanded at an annualised rate of 1.6% in Q1, and while the headline result undershot expectations, the detail suggests this is not reflective of a weak domestic economy. Personal consumption rose 2.5% with services rising 4.0% – the fastest rise in services since 2021. A sharp rise in imports, centred on services, drove the weakness in the quarter. Excluding trade, GDP came in within expectations. Strong growth was accompanied by strong prices – the PCE ex. food and energy rose 3.7%yr and implies a 0.4%mth rise in core PCE out later today. This would mark a reacceleration in PCE inflation after two months of deceleration. All together, the US economy is in a strong position with consumption supporting inflation.

Durable goods orders rose 2.6%mth in March and 0.2%mth stripping out the volatile transportation and defence categories. Together with the tepid non-residential investment data from GDP, the outlook for growth in manufacturing and investment remains clouded by high borrowing costs. Recent data will likely prompt a more hawkish tone from the FOMC to temper inflation expectations, noting that it will take time for restrictive policy to cool inflation.

Key Highlights

• USD/JPY rallied further above the 155.00 resistance.
• A major bullish trend line is forming with support at 155.20 on the 4-hour chart.
• EUR/USD is struggling to clear the 1.0750 resistance zone.
• Crude oil prices could decline and revisit the $81.00 level.

USD/JPY Technical Analysis

The US Dollar remained in a strong uptrend above 152.00 against the Japanese Yen. USD/JPY extended its increase above 155.00 and traded to a new multi-decade high.

Looking at the 4-hour chart, the pair traded above 155.50 and settled well above the 100 simple moving average (red, 4-hour) and the 200 simple moving average (green, 4-hour). The pair seems to be consolidating gains above the 23.6% Fib retracement level of the upward move from the 153.59 swing low to the 155.74 high.

Immediate resistance is near the 155.75 level. The first key resistance is near the 156.00 zone. A clear move above the 156.00 resistance could send the pair further higher. In the stated case, USD/JPY bulls could even aim for a move toward 157.50.

Immediate support is near the 155.20 level. There is also a major bullish trend line forming with support at 155.20 on the same chart.

The next major support is at 154.90. If there is a downside break below the 154.90 support, the pair might test 154.00. The main support is now forming at 153.50. Any more losses might send the pair toward 152.00.

Looking at Oil, the price extended losses and it seems like the bears could aim for a move toward the $81.00 level in the near term.

Economic Releases

• US Personal Income for March 2024 (MoM) - Forecast +0.5%, versus +0.3% previous.
• US Personal Spending for March 2024 (MoM) - Forecast +0.6%, versus +0.8% previous.

• GBPCAD reversed from key support level 1.6910
• Likely to rise to resistance level 1.7230

GBPCAD currency pair recently reversed up sharply from the key support level 1.6910, (former monthly low from February), standing well below the lower daily Bollinger Band.

The upward reversal from the support level 1.6910 created the strong daily Japanese candlesticks reversal pattern Bullish Engulfing – which stopped the pervious wave 2.

Give the strength of the support level 1.6910, GBPCAD currency pair can be expected to rise further to the next resistance level 1.7230 (which stopped the pervious wave b).

• GBPAUD reversed from support level 1.9135
• Likely to rise to resistance level 1.9360

GBPAUD currency pair recently reversed up from the pivotal support level 1.9135, which has been reversing the price from the start of April, intersecting with the lower daily Bollinger Band and the 50% Fibonacci correction of the previous upward impulse 1 from December.

The upward reversal from the support level 1.9135 created the daily Japanese candlesticks reversal pattern Hammer Doji.

Give the strength of the support level 1.9135, GBPAUD currency pair can be expected to rise further to the next resistance level 1.9360.

Japan's Tokyo CPI showed significant slowdown in April. CPI core (excluding food) dropped from 2.4% yoy to 1.6%, substantially below the expected 2.2% yoy.

CPI core-core, which excludes both food and energy, also slowed from 2.9% yoy to 1.8% yoy, marking the slowest pace since September 2022.

Services inflation, a significant component of the CPI, decreased from 2.7% yoy to 1.6% yoy. This notable drop is largely attributed to policy interventions by the Tokyo metropolitan government to make some educational tuition free.

Overall headline CPI, which includes all items, also fell from 2.6% yoy to 1.8% yoy.

Part II: A Brief Review of Past Episodes of Stagflation

Summary

• In the first installment of this series, we presented a simple framework to characterize stagflation and identified 13 instances in the United States since 1950.
• Episodes vary in severity, but each posed unique challenges to monetary policymakers. In this second report, we briefly review historical instances of stagflation and their accompanying monetary policy decisions.
• Six of the 13 episodes of stagflation occurred in the 1970s as oil price shocks, imbalanced fiscal and monetary policy and robust labor cost growth placed upward pressure on prices and weighed on output growth.
• The episodes outside the 1970s have ranged from mild to moderate, with the exception of the post-COVID pandemic occurrence, a topic that we will turn to in the final installment of this three-report series.
• Over time, historical instances of stagflation have often been met with accommodative monetary policy to support employment, despite elevated price growth.
• The degree to which the accommodative policy stance exacerbated stagflation depends on the drivers of the inflationary bouts themselves and whether the economy's structure would help entrench or dilute price momentum.
• External factors, such as oil price shocks, were associated with severe episodes of stagflation, but expansionary fiscal policy enacted amid a tight labor market also played a role. Those dynamics mirror the current environment, as the unemployment rate is at a decades' low and the fiscal deficit is swelling. Will the economy suffer from stagflation in the near term?

All Stagflation Is Not Created Equal

We presented a simple framework to characterize stagflation in the first installment of this series. Using that framework, we identified 13 instances of stagflation in the United States since 1950 (Figure 1). Episodes vary in severity, but each posed unique challenges to monetary policymakers. In this second installment, we briefly review historical instances of stagflation and their accompanying monetary policy decisions. The distinctive experiences point to an economy whose structural drivers of growth have shifted over time, which underscores the idea that a policy enacted back in the 1970s may not have the same effect today as it did then.

Figure 1

Mild Cases

The first mild episode of stagflation occurred in 1971. The U.S. economy had just emerged from a recession that ended in the final quarter of 1970. Real GDP growth was sluggish, unemployment was elevated at around 6% and inflation was persistent. The Chair of the Federal Reserve at the time, Arthur Burns, was keen on supporting the labor market and moved forward with expansionary policy in late 1971 by lowering the target range of the fed funds rate by 200 bps (Figure 2). Around the same time, President Nixon ordered that the gold standard be abandoned, un-anchoring the U.S. dollar, and authorized a 90-day freeze on wages and prices to dampen inflation. The bold fiscal approach squashed inflation shortly after its implementation, and output growth quickly picked back up in 1972, which together effectively ended this mild case of stagflation. The reprieve was short-lived, however, as the following instance of stagflation in 1973-1975 saw the year-over-year change in the CPI rise to its highest since 1947.

The next two mild episodes occurred in 1976 and 1977-1978, both in the absence of a recession. In the lead up to these episodes, a 1973 oil embargo placed on the United States by a coalition of Middle Eastern countries sent domestic oil prices skyrocketing, as the U.S. was heavily reliant on petroleum imports at that time. While the embargo was lifted in 1974, a series of global oil production cutbacks led to a dramatic rise in energy prices throughout the 1970s, which passed through to higher wages via price indexation clauses in many union workers’ wage contracts.1 The bid up in oil and labor costs squeezed business profit margins and led to a trend rise in the unemployment rate throughout the decade, while the CPI also ripped higher on a year-over-year basis. Yet the paths of CPI inflation and the unemployment rate, while on upward trajectories, were incredibly variable, which obscured the view for monetary policymakers. The target range of the fed funds rate was mostly steady in 1976-1977 before drifting higher in 1978. Elevated and volatile inflation led to choppy real GDP growth, and that dynamic resulted in the break up of these two mild cases of stagflation.

The final two mild episodes took place in 1995 and 2006 when inflation was relatively tame. In the first half of 1995, CPI inflation was above the 2% benchmark, and real GDP growth was roughly three percentage points below its prior cycle’s average of 4.4%. An aggressive monetary policy tightening cycle the year prior likely contributed to the slowdown in output growth—the FOMC had just wrapped up its 1994 tightening cycle, where it lifted the upper bound target by 300 bps in just 12 months (Figure 3). While price growth was strong, accelerating labor productivity amid the broad adoption of computers in the business sector eventually put downward pressure on inflation and supported economic output in the back half of the 1990s. In view of the pickup in the economy's potential output, the FOMC lowered the target range by just 75 bps in late 1995 and early 1996 to stimulate near-term activity before holding policy mostly steady at an upper bound of 5.25-5.50% through Q2-1998.

In 2006, real GDP growth slowed to a crawl for two straight quarters and the CPI edged up to 3-4%. Residential construction and consumer spending were losing momentum, while the dollar was depreciating. Similar to the 1995 episode, the FOMC had been gradually tightening policy at a 25-bps pace from 1.00% in mid-2004 to 5.25% by mid-2006. The updraft in borrowing costs weighed on output growth, while the weaker dollar and rising commodity prices placed upward pressure on inflation. Yet contained inflation expectations and tamped-down aggregate demand helped CPI inflation ease below the 2% target by Q3-2006, which ended this mild case of stagflation while the FOMC remained on hold at an upper bound of 5.00%.

Moderate Cases

In the first instance of moderate stagflation, CPI inflation picked up to above 3% in 1957 after averaging just 0.6% the prior two years. William McChesney Martin, the Chair of the Federal Reserve, responded with tight policy that led to a sharp recession that year. (The Fed primarily conducted monetary policy via changing bank reserve ratio requirements at the time). The credit crunch, as well as a marked decline in U.S. exports amid a global recession that coincided with the 1957 influenza pandemic, led to a sharp 4% contraction in real GDP from Q3-1957 to Q1-1958. The activity slowdown helped to significantly cool inflation, however, and the CPI returned to its prior cycle’s average of 0.9% by Q1-1959.

The second moderate stagflation episode occurred from 1989 to 1991. Inflation was gaining momentum as the new decade rolled around, and the FOMC was incrementally increasing the fed funds rate from 1988 through early 1989. However, economic activity started to wobble in 1989, causing the FOMC to pivot to an accommodative stance by mid-1989. Then, an energy shock during the Gulf War led to higher food and gas prices in late 1990, causing the CPI to peak at 6.2% year-over-year in Q4-1990. The mixture of the energy price shock and accommodative monetary policy led to a gradual pace of disinflation that kept the CPI above the 2% target through 1991 and real GDP growth that averaged roughly four percentage points below the prior cycle’s average.

The final two episodes of moderate stagflation took place in 2000-2001 and 2008. In the early 2000s, tight natural gas supplies and elevated medical care costs were notable drivers of elevated inflation. The FOMC was on hold at an upper bound target of 6.50% through most of 2000, but it cut rates as the calendar turned to 2001 amid a rise in the unemployment rate and the collapse of several technology companies. Real GDP growth was only mildly negative over the episode but remained below its prior cycle’s average of 3.8%. In 2008, skyrocketing gasoline and other commodity prices drove the pickup in the CPI. The FOMC started to cut rates in the second half of 2008 in response to mounting signs of significant financial market stress, a rising unemployment rate and declining consumer spending. Real GDP growth was choppy during this episode as the economic shocks of the financial crisis developed gradually. In short, the recessions during the 2001 and 2008 episodes of stagflation, while vastly different in depth, helped dampen inflation quickly. The CPI fell below 2% year-over-year before each recession ended.

Severe Cases

The first severe episode of stagflation took place 1969-1970, coinciding with a recession. In the run-up to this episode, President Lyndon B. Johnson’s Great Society programs had injected significant amounts of fiscal stimulus in the economy, while military investment was also ramping up amid the Vietnam War (Figure 4). The ballooning in fiscal spending coincided with a tight labor market; the unemployment rate was running below 4% in the late 1960s. At this time, the Federal Reserve was also following an “even-keel” policy where it would hold interest rates steady between the announcement of a Treasury issuance and the eventual bond sale.2

As government spending ramped up, Treasury issuances occurred frequently and curtailed the Fed’s ability to conduct monetary policy effectively. Ultimately, expansionary fiscal policy, combined with an economy near full employment, appeared to be the primary culprits of the 1969-1970 episode's high inflation. On a year-ago basis, the CPI was more than three standard deviations above the prior cycle’s average of 1.4% for seven consecutive quarters, while real GDP growth trended well below the prior cycle’s average of 6.7%.

The next two episodes of severe stagflation occurred in 1973-1975 (7 quarters) and 1979-1982 (16 quarters). Two major oil price surges (Figure 5)—the first associated with the aforementioned oil embargo on the United States in 1973 and the second associated with the Iranian Revolution in 1978-1979—sent shock waves through the economy, leading to elevated CPI inflation of the cost-push variety. At the time, the consensus among economists was that monetary policy tools were not effective at remedying inflationary shocks caused by exogenous events, but that they were still instrumental to maximizing employment. Thus the FOMC primarily enacted accommodative policy during these episodes to support the employment side of the economy, which was struggling underneath the weight of sluggish output growth amid quickly rising and variable business input costs.

With the Federal Reserve generally on an accommodative stance, the federal government instituted policies aimed at halting robust price growth. As mentioned in the Mild Cases section, President Nixon ended the dollar's convertibility to gold, which contributed to the eventual end of the Bretton Woods System, and enacted price and wage controls to slow inflation in 1971.3 The Ford Administration introduced the Whip Inflation Now (WIN) program in 1974, which encouraged consumers to voluntarily cut back on spending.4 Both programs were largely unsuccessful at stamping out inflation’s underlying strength, especially as the Federal Reserve was maintaining a counteracting accommodative stance at the same time. Momentum in input prices pushed the CPI higher through the back half of the 1970s and the year-over-year rate peaked at around 14.5% in 1980. The 1973-1975 and 1979-1982 stagflation episodes are broken up into two separate instances because inflation slowed in the middle of the decade closer to 5%-6% while real GDP growth treaded water at around a 2% average.

The final episode of stagflation occurred in the wake of the COVID pandemic, which is a topic that we will turn to in the final installment of this series. For now, we can see that historical instances of stagflation have often been met with accommodative monetary policy to support employment, despite elevated price growth. The degree to which the Federal Reserve's accommodative stance exacerbated stagflation depends on the drivers of the inflationary bouts themselves and whether the economy's structure would entrench (e.g., the 1970s) or dilute (e.g., 2000-2001) price momentum. External factors, such as oil prices shocks, were associated with severe episodes of stagflation, but expansionary fiscal policy enacted amid a tight labor market also played a role. Those dynamics mirror the current environment, as the unemployment rate is at a decades' low and the fiscal deficit is swelling. Will the economy suffer from stagflation in the near term?5

Endnotes

1 - Around 60% of workers under collective bargaining agreements had cost of living clauses in their contracts in the 1970s. Consequently, the oil price’s shock to inflation led to an automatic acceleration in wages, which pushed input costs up further.

2 - See a 1967 memo to the Federal Open Market Committee on the Committee's interpretation of the "Even Keel" Policy.

3 - See a short explainer from the International Monetary Fund on the end of the Bretton Woods System.

4 - See a short article from the Federal Reserve Bank of New York's research library for more information on the Whip Inflation Now campaign.

5 – This series is based on a 2024 American Economic Association Annual Meeting paper by Azhar Iqbal and Nicole Cervi titled "Characterizing Stagflation into Mild, Moderate and Severe Episodes: A New Approach". Please contact the authors if interested in the full paper.

• Euro loses ground as European Central Bank signals rate cuts
• But only against US dollar - holds strong against pound and yen
• Eurozone GDP and inflation stats on Tuesday will decide what’s next

Imminent rate cuts bruise euro

It’s been a difficult year for the euro, which has already declined 3% against the dollar as the economic divergence between the Eurozone and the United States has convinced investors the ECB is set to cut interest rates faster and deeper than the Fed.

Economic growth in the euro area has been stagnant for about a year now and inflation has cooled rapidly, falling to just 2.4% in March. As such, ECB officials have made it abundantly clear they intend to slash rates in June, so that looks almost like a done deal. The real question is how they will proceed afterwards.

In this sense, some leading indicators have flashed encouraging signals lately, with business surveys pointing to a reacceleration in growth and inflationary pressures. If that is reflected in official data soon, the ECB might decide to ‘play it slow’ with any subsequent rate cuts beyond June.

GDP and inflation data on the radar

Next week, the spotlight will fall on the first estimate of Eurozone GDP growth for Q1 and inflation stats for April, both due on Tuesday. The unemployment rate for March will follow on Friday.

Business surveys were consistent with GDP expanding by 0.3% in the first quarter compared to the preceding quarter, when growth was flat. The same surveys warned that inflation fired up again in April as companies raised their selling prices at a faster clip, reflecting rising wage and energy costs.

A reacceleration in both growth and inflation could throw the euro a much-needed lifeline, bolstering the single currency through the interest rate channel as traders unwind some bets of rapid ECB rate cuts.

Looking at the euro/dollar chart, the pair has been trading below a downtrend line this year with a clear structure of lower highs and lower lows, which keeps the prevailing trend negative.

That said, a strong batch of data could allow the latest recovery to continue, perhaps towards 1.0800, a region reinforced by the 50- and 200-day simple moving averages (SMAs).

On the downside, a disappointment in the upcoming data can bring the pair under renewed selling interest. A potential drop back below the 1.0690 zone would shift the focus towards the April lows near 1.0600.

Euro outlook 

In the bigger picture, the euro’s losses this year have been concentrated mostly against the mighty US dollar. Against the British pound, the single currency has only lost 1%, while it has risen almost 7% against the sinking Japanese yen.

Judging by economic performance, these patterns can persist. The US economy is the strongest in terms of growth, so the dollar may continue to outperform in the foreseeable future, especially if stock markets remain shaky. The Eurozone and UK economies are in similar shape, which suggests those two currencies could continue to trade almost in lockstep.

Hence, the euro’s best chance at further gains may be against the yield-starved Japanese yen. In this sense, the main risk is the prospect of FX intervention by Tokyo. That said, the yen might need to fall even further before authorities step in.

The dollar strengthened, and stocks fell after statistical data from the US. The focus was on the preliminary estimate of GDP for the first quarter. Annualised quarterly growth came in at just 1.6%, down from the 2.5% and 3.4% previously forecast. Disappointment increased given that exceeding forecasts has become the norm. GDP growth for the same quarter a year earlier fell to 3.0% from 3.1%.

In contrast, the price index showed a 3.1% increase from 1.6% previously. Thus, the U.S. economy simultaneously faced increased inflationary pressures and slowing growth. This has caused even more concerns among those who fear stagflation.

At the same time, a new batch of very positive weekly unemployment data was released. Initial jobless claims fell to 207K, the lowest since February. The number of repeat claims fell to 1781K – the lowest in three months. It is worth noting that these are very low figures by historical standards. The tense situation in the labour market will create domestic inflationary pressures even if commodity prices start to decline.

The British is in positive territory on Thursday. In the North American session, GBP/USD is trading at 1.2492, up 0.23%.

US GDP slows to 1.6%

Is the US economy finally slowing down? Recent key indicators, from nonfarm payrolls to consumer inflation have been stronger than expected, but the markets could hear the “thud” of today’s initial GDP for the first quarter, which at 1.6% y/y missed the market estimate of 2.5% and was sharply lower the Q4 2023 reading of 3.4%. Consumer spending slipped to 2.5%, down from 3.4% in Q 2023.

Meanwhile, there was bad news on the inflation front, as the personal expenditures price index (PCE), which is considered the Fed’s preferred inflation gauge, jumped 3.4% y/y in the first quarter, up sharply from 1.8% in the fourth quarter and its largest gain in a year. Core PCE, which excludes food and energy, rose 3.7%, above the market estimate of 3% and crushing the fourth quarter gain of 2%.

Today’s report is a discouraging sign for the Fed, as growth was lower than anticipated and inflation was higher than expected. The rise in inflation shouldn’t come as a major surprise though, as consumer inflation has risen in the past two releases.

The markets reacted negatively to the news, with investors now pricing in just one rate cut in 2024, according to the CME FedWatch tool. Market expectations for a rate cut have fizzled since January, when the markets were exuberantly pricing in up five or six rate cuts during the year. A rate hike, which would have been unthinkable at the start of the year, is a real possibility if the economy remains in good shape and inflation continues to rise – the options markets have priced in a 20% probability of a rate hike within the next 12 months.

GBP/USD Technical

• GBP/USD tested support at 1.2458 lower. Below, there is support at 1.2412
• There is resistance at 1.2544 and 1.2590