1970s US Stagflation: Investopedia defines stagflation as’ the combination of slow economic growth, high unemployment, and a high rate of inflation.’ US government military spending during the Vietnam War contributed to inflation, which rose from 1 percent in 1961 to 5.8 percent in 1970. Brent oil price rose by 3,288 percent from $1.21/barrel in January 1970 to $42/barrel in November 1979 due to the OPEC oil embargo and the Iranian Islamic Revolution. US inflation soared from 3.3% in 1972 to 13.6% in 1980. The Fed’s loose inflationary monetary policy to spur GDP growth and employment led to its Federal Funds Rate (FFR) falling from 9.19 percent in August 1969 to 3.3 percent in February 1972. President Richard Nixon’s control of wages and prices led to inflationary shortages.
The unemployment rate rose from 3.4 percent in May 1969 to 9 percent in May 1975. The US Full Employment and Balanced Growth Act of 1978 set the NAIRU (Non-Accelerating Inflation Rate of Unemployment) at 4 percent. GDP growth rate fell from 6.5 percent in 1966 to 0.2 percent in 1970. It further plummeted from 5.6 percent in 1973 to a contraction of 0.5 percent in 1974 and 0.2 percent in 1975.
FED 1980s Response to Stagflation
Hawkish FED Chairman Paul Volcker was appointed in August 1979. He hiked the FFR to 19.1 percent by July 1981 to halt inflation, which rose to 13.5 percent in 1980. High FFR triggered a GDP contraction of 1.8 percent in 1982. The unemployment rate rocketed to 10.8 percent in 1982. The FED used an implicit 2 percent low and stable inflation target until 2012, when the FOMC made it explicit.
Current US Stagflation Threats
On April 2, 2025, President Trump, on Liberation Day, announced Reciprocal Tariffs that shocked the world. The subsequent selloff in financial markets, including US bonds and equities, led to a crash in stock markets and a weakening of the USD against the Euro. President Trump paused the implementation of the tariffs for 90 days, except for China. FOMC Summary of Economic Projections expects stagflation. It revised the US 2025 GDP growth down to 1.7 percent from 2.1 percent and the unemployment rate up to 4.4 percent from 4.3 percent.
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It forecasts PCE inflation and Core PCE Inflation to rise from 2.5 percent to 2.7 percent and 2.8 percent, respectively. US households and the private sector continue to stock up on imports ahead of the tariffs’ commencement. Americans expect tax cuts and tariffs to be inflationary, while the FED prays that they are transitory and non-persistent. University of Michigan Inflation Expectation (MICH) rose from 2.6 percent in November 2024 to 5 percent in March 2025.
Scenario 1- FED Prioritize GDP & Employment Growth – Upsides for Africa
The Fed would cut the FFR twice by 25 basis points each to the 3.75-4 percent range, which would deliver the 3.9 percent FFR terminal rate in 2025. The Secured Overnight Financing Rate (SOFR) fall would match the Effective FFR. USD would weaken as EMDEs’ currencies strengthen as investors seek higher returns from non-US assets. The weaker dollar means importers win, exporters lose, and US outbound tourists decline as the dollar’s purchasing power overseas decreases.
EMDEs funding freeze FCY deficit financing would ease from lower SOFR and sovereign risk premia as FCY debt default risk recedes, and credit ratings are upgraded. Reduced overdependence on LCY deficit financing would result in lower treasury yields and decreased government LCY debt repayment costs. EMDEs central bank policy cuts would spur growth of credit, GDP, and jobs.
A weak dollar would herald higher USD liquidity and pre-empt banks breaching Single Obligor Limits (SOL). Currency translation would see YOY loan and assets quoted in LCY fall. Banks would enjoy a lower cost of deposits and funds due to falling rates and reduced government crowding out of term deposits. They would enjoy higher demand for credit, lower NPLs, declining loan provisions, and loosening credit underwriting standards to spur credit growth. Banks would lengthen the tenor of loans, increase their appetite for large-ticket loans, and lend to riskier sectors, such as MSMEs and agriculture. Falling Eurobond and treasury bond yields would inversely increase bond prices, thus reducing the mark-to-market (MTM) losses.
Scenario 2- FED Prioritize Curbing of Inflation – Downsides for Africa
The FOMC may continue to pause the FFR at 4.25-4.5 percent or hike it upwards. Secured Overnight Financing Rate (SOFR) may pause at 4.39 percent or trend towards its July 2024 high of 5.4 percent.
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The re-emergence of a Strong USD would drive the depreciation of EMDE currencies through a flight to safety of USD-denominated bonds and equities. A Strong Dollar makes exporters winners and importers losers, while US outbound tourists are likely to rise.
FCY deficit financing funding freeze for EMDEs would worsen due to higher SOFR and sovereign risk premia as FCY debt default risk increases and ratings are downgraded. Dependence on IMF BOP and budget loans would skyrocket. Due to a rise in dependence on LCY deficit financing, bond yields rise, and government debt costs increase to narrow the fiscal space. EMDEs’ central banks would converge their policy rates to match the Fed hikes in order to defend their local currencies against depreciation due to capital flight resulting from a mismatch in international interest rate parity.
Banks would be forced to increase their buffers for liquidity, asset quality, and capital amidst crowding out of the private sector from credit and banks from term deposits. A Strong Dollar would reduce USD liquidity due to precautionary and speculative motives of money while increasing the likelihood of single obligor limit breach. The total loan book and assets in LCY would balloon. The bank cost of deposits and DFI borrowings would rise. Rising lending rates would dampen demand for credit, increase NPLs and provisions, occasion tightening of lending standards, and contraction in the loan portfolio. Banks would prefer short-term, high-velocity digital loans and tend to shy away from risky sectors. Rising Eurobond and LCY bond yields would likely cause an inverse fall in bond prices, heralding the return of mark-to-market (MTM) losses, which triggered the collapse of Silicon Valley Bank (SVB), Signature Bank, First Republic Bank, and Credit Suisse.
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