The US will avoid stagflation and will suffer milder 'slowflation' instead, because inflation has already peaked: UBS

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The US will avoid stagflation and will suffer milder 'slowflation' instead, because inflation has already peaked: UBS
Inflation has peaked, according to UBS strategists.Mark Lennihan/AP Photo
  • UBS said the US economy is likely to enter "slowflation," not stagflation, as inflation has already peaked.
  • Slowflation is slow growth alongside moderately high levels of inflation, its strategists said Tuesday.
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The US is likely to dodge stagflation and will suffer "slowflation" instead, which history shows is a better environment for stocks, according to UBS strategists.

Stock markets have faltered in 2022 as investors grappled with inflation fears and the prospect of stalled growth, uncertain as to how deep the economic pain will be.

One keen worry has been the prospect of stagflation — a toxic mix of persistent inflation and sluggish growth. Investors' fears about stagflation are the highest they have been since the 2008 financial crisis, according to the most recent Bank of America fund manager survey.

But the market can expect the slowdown to be less severe, a team of UBS strategists led by Nicolas Le Roux said in a Tuesday note.

"In the next 12-36 months, we believe we are likely to enter a period of slowflation, which we have defined as a period of 'medium to low' growth combined with 'medium to high' inflation," they wrote.

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The strategists based their forecast on the view that inflation has already hit its highest level in the US and is likely to ease in future.

"Inflationary pressures are elevated today, especially in developed markets, but are likely to ease from here, in our view. Our economists believe US inflation has already peaked, and Europe's will do so by September 2022," they said.

In May, the rate of inflation in the US accelerated to its fastest pace since December 1981, hitting 8.6%, as energy and food prices surged thanks to Russia's war on Ukraine.

That has given the Federal Reserve impetus to push on with its plan to tame inflation with aggressive interest-rate increases, which it kicked off with a 75 basis point hike.

Given the Fed is focused on beating inflation, Guggenheim's Scott Minerd said Tuesday it's unlikely to care about the current stock sell-off until panic floods the market.

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According to UBS, slowflation has been easier on stocks, based on an analysis of episodes dating back to 1970. They found sectors had average monthly returns were 0.36% positive, compared with 0.27% negative for stagflation.

"Stocks have unsurprisingly delivered better returns during slowflation [...] than during stagflation periods," they said.

But several influential commentators see stagflation as a more likely outcome. Noted economist Mohamed El-Erian, has said stagflation is unavoidable, while hedge fund giant Bridgewater has warned the US is on the cusp of stagflation and markets are yet to fully realize it.

Read more: Buy these 13 cheap stocks that will outperform in a recession-fueled bear market, according to Morningstar

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