Are We Heading Toward Stagflation?

We may be heading into stagflation, and here's why.

According to Fed funds futures, there's currently a 90% chance of a 25bp rate hike, moving the range from 350–375 to 375–400 basis points. This hike is being driven mainly by inflation, which has picked up over the past month.

But here's the key question: why would raising rates further push the economy toward a worse scenario this time, instead of fixing it?

Two kinds of inflation

There are two forces that push prices up. The first is money supply — this kind of inflation can be contained with monetary policy, because raising the Fed funds rate encourages banks and money market funds to park savings at the Fed instead of lending it out into the economy. It trades growth for lower prices.

The second is exogenous inflation — driven by supply chain disruptions, geopolitical shocks, energy issues, and similar factors. This kind of inflation can't be fixed with monetary policy, because it isn't caused by an excess of money supply.

So raising rates into exogenous inflation just slows economic activity, while inflation stays elevated until the underlying disruptions ease and oil prices settle back down — say, around $60.

What markets are pricing in

That second scenario is exactly what's being priced into U.S. Treasury yields and rates across developed markets right now, as inflation expectations keep climbing.

Treasuries are considered the safest asset in the world, so a rise in their yields feeds directly into equity valuations and public balance sheets: a higher risk-free rate means future cash flows get discounted at a higher rate, which lowers valuations today.

Conclusion

If we are indeed heading into a slowdown with persistent inflation, this could open up real investment opportunities.

Supply chain and oil disruptions won't last forever. Once old trade routes reopen, the market should see more oil supply — from Iran's reserves, new fields in Russia, and private control over Venezuela's oil deposits. It's only a matter of time before the storm passes.

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