STAGFLATION Is Back And IT'S Going to BE UGLY..

Wall Street is largely ignoring the 40% chance of stagflation hitting the US economy by the end of the year. While the stock market, NASDAQ, and corporate earnings are at record highs, underlying derivative markets and economic models point towards a different reality than the celebrated 'soft landing'.

Stagflation is an economic scenario characterized by rising prices, slowing or declining economic growth, and a cracking labor market. It's the 'worst of all possible worlds' for central banks, as standard policy tools to fight inflation (raising rates) can worsen job growth, and measures to boost growth can exacerbate inflation.

The probability of stagflation has increased dramatically, with Cali, a prediction market, showing a near 40% chance by the end of 2016, up from 11% three months prior. Moody's AI-driven recession probability model is at 49%, a threshold that has historically preceded every US recession in the last 80 years.

The Iran war oil shock is not over; the Strait of Hormuz crisis caused the largest oil supply disruption in history. Energy price shocks hit consumers in cascades: first pump prices, then diesel (impacting transportation of goods), then fertilizer (affecting food production costs), ultimately leading to higher grocery bills that break consumer behavior and drive stagflation. The Dallas Fed predicts a significant increase in inflation in 2026 even under an optimistic scenario.

Inflation is re-accelerating, while economic growth is slowing. Consumer credit card debt has reached $1.25 trillion, real hourly earnings fell by 0.3% in April, and wages at 3.6% are losing to inflation at 3.8%. Major retailers like Kroger are cutting prices due to customers avoiding purchases, indicating a weakening consumer base.

The 1970s stagflation crisis also began with an oil shock, pushing the Fed into an impossible position where every policy tool worsened either inflation or unemployment. It took a brutal recession and 20% interest rates under Paul Volcker to break the cycle. The current setup shares enough similarities to make the 40% probability actuarial, not alarmist.

In a stagflation scenario, the Fed faces a dilemma: it cannot cut rates without admitting defeat in the inflation fight, nor can it hike aggressively without accelerating economic slowdown and unemployment. The usual post-war solution of raising rates until inflation breaks might not work with high consumer debt and negative real wages.

Three key signals to watch in the next 30-60 days are: (1) The May jobs report (June 5th) – a weak number would indicate cracking economic momentum. (2) The FOMC meeting (June 16th-17th) – watch for language regarding potential rate hikes, which would signal the Fed's view on inflation risk. (3) Supply chain indicators – monitor shipping costs, fertilizer prices, and food producer index data for signs of future grocery inflation from the second wave of the oil shock.

The stock market's record highs reflect strong corporate earnings, but this doesn't align with the economic reality for 70% of the population at the gas pump and grocery store. This divergence cannot last indefinitely, and when consumer spending (70% of GDP) cracks under inflation and stagnant wages, every asset class will suffer. Stagflation is a real threat, not a relic of the past, with the second inflation wave from the Iran war yet to fully materialize.