As inflation soars and economic growth stalls, the growing threat of “stagflation” is hitting the economy and investment markets hard. The term stagflation combines “stagnant” with “inflation” – and here’s what you need to know about it.

As the pandemic has wound down, demand for goods and services has skyrocketed. In the wake of reopening economies across the globe, the pull of surging demand has strained global supply chains, and geopolitical events have exacerbated the issue. In response, inflation has soared, forcing central banks to raise interest rates to quell demand, increasing the threat of an economic slowdown – or even recession.

Increasing stagflationary conditions impact investors too: rising interest rates ripple into rising bond yields, hitting bond prices (bond prices and yields move inversely). Stocks fall sharply as well, as investors increasingly anticipate companies will struggle to generate sustained profits in these challenging conditions.

Sticking the landing: Aiming for soft, bracing for hard

Unfortunately, the accepted remedy to tame inflation often only adds to the pain, at least in the short run. In response to rising prices, central banks must raise interest rates, in turn increasing borrowing costs for businesses and consumers, and further crimping their dwindling resources. While this can stifle demand and gradually inflation, it can also stifle economic growth. If the central banks cause a recession, especially a painful one, that’s called a “hard landing.” If they manage to finesse a slowdown but it doesn’t result in a recession – or at least a prolonged and nasty one – that’s called a “soft landing.”

Fortunately, there is still time for central bankers to engineer a soft landing and avoid a hard one, and a recession, especially a painful one, is not a forgone conclusion.

Stagflation mitigation

Here are four things to consider in light of the increasingly stagflationary environment:

1. Debt: If borrowing costs are rising, it can be timely to review your debt service costs, and to consider reducing debt or deferring purchases that may increase it.
2. Investment portfolio: The market’s negative response to it can provide a “stress test” and an opportunity to review your portfolio with your advisor to determine whether it requires any rebalancing. Taking advantage of lower asset prices can also be a smart strategy when markets are stressed.
3. Quality: In times of economic and market stress, certain types of assets tend to perform better –or “less worse” – than others. A focus on assets that are considered high quality because they can consistently perform through challenging economic circumstances can help reduce volatility.
4. Fixed income: When interest rates rise, the bond market typically sees yields soar and prices fall. On the positive side, fixed-interest-rate investments (e.g., GICs) tend to see their returns rise, while newly higher yields on bonds offer the opportunity to “reset” coupon payments at higher levels, creating the opportunity to enhance fixed-income returns over the longer term.

If you have questions about stagflation and its potential impact on your portfolio and investment plan, speak to us today.

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