The Federal Reserve is going to have a difficult time wrestling inflation under control and that means more pain ahead for stocks and other assets, says Stephen Roach, former
Morgan Stanley
chief economist and now a senior fellow at Yale University.
The U.S. economy could face stagflation, but not the variety seen in the 1970s and 1980s, Roach tells Barron’s. Inflation, though beginning to recede, will still be sticky and unlikely to return to the Federal Reserve’s 2% target anytime soon, he adds.
Indeed, at this week’s annual spring meetings of the International Monetary Fund and World Bank, IMF Managing Director Kristalina Georgieva stressed the fragile situation in a world with anemic economic growth: “If growth is slowing down but inflation is not, shouldn’t we be thinking more about vigilance?”
The Federal Reserve may need to pause in its inflation fight to deal with additional troubles in the banking sector as rates rise. Roach cautions that the financial system itself could be in for a “very painful adjustment” because it is still positioned for an era of accommodative monetary policy.
The Fed, Roach says, made a huge mistake by keeping rates too low for too long and is now compensating by bringing the policy rate back up very quickly, which means there will be strains in the system. The Fed’s other big mistake, he says, was regulatory, adhering to a stress test methodology of the wrong scenario and not assessing more improbable risk scenarios that turned out to not be so improbable.
“It was a terrible mistake. Who is to say how many other financial institutions will be facing the type of a run on their deposits [seen in recent regional bank turmoil] because of underwater bond exposure?” Roach says.
Where could further strains emerge? Roach is concerned about commercial real estate, especially as leases expire and tenants don’t renew in the world reshaped by the pandemic.
Another area of concern: crypto. Roach, speaking after a day at an alternatives conference in London, said he was disturbed by the number of crypto representatives present that were “feeling very confident about their strong prospects,” adding to his concern about complacency in the rebound in crypto of late.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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