Executive Summary
There has been some recent chatter from economists about the possibility of a stagflationary period precipitated by demographic and deglobalisation forces. Stagflation is characterized by simultaneous high inflation, sluggish economic growth, and elevated unemployment. It last occurred widely in the 1970s–early 1980s, driven by oil shocks, productivity slowdown, and policy errors (easy money and slack wage–price controls). Conventional assets such as Shares and Bonds do not perform well in this environment, whereas commodities and selected real assets (Property & Infrastructure) can provide safe harbour. This report examines the potential for stagflation to once again take hold and what investors can do about it.
Our core view is that over the next 12 months, slowing growth and not price inflation is the main concern. Policy choices and longer-term shifts are negatively impacting both supply and demand, cooling activity and jobs growth, while only modestly lifting prices. The good news is long-term inflation expectations remain steady (similar to those of central banks), which helps prevent today’s price pressures from becoming permanent. However, looking 24-36 months out, the risk of stagflation rises unless productivity improves; this is where AI needs to fulfill its promise.
Why growth looks softer near-term.
Recent economic activity has cooled, and gains in Payroll data have slowed markedly. One research house (BCA) believes that the official unemployment numbers may, in fact, be understated due to more people being underemployed or no longer actively seeking employment. Real consumer spending is barely above late-2024 levels, signalling softer household momentum. Business investment is also under pressure: roughly two-thirds of US imports are intermediate and capital goods, so broad tariffs operate like a tax on inputs and equipment. Despite a boom in the construction of Data centres, manufacturing construction has begun to trend lower, and capex intentions remain subdued. Australia’s economy is still expanding, but slightly below its long-term trend. The latest September inflation reading rose to 3.0%, and is now back at the top of the RBA’s 2–3% target band—an unwelcome uptick that is likely to pause any further near-term interest rate cuts to help stimulate growth.
Where US inflation expectations stand — and why does it matter?
As US inflation expectations set interest rates, and in turn, US interest rates are the basis of pricing almost every asset class in the world, it’s important to understand the direction of US inflation. US headline and core inflation re-accelerated modestly in recent months, helped by higher import and retail prices on tariffed goods and by rising electricity prices. Electricity now poses a classic stagflationary risk as its ubiquitous consumption contributes to inflation at the margin while squeezing real activity. Despite this, it appears that the market’s long-term inflation expectations remain well-anchored, given the similarity of the implied inflation of 2.3% (as measured by the US 5-year, 5-year forward breakeven) and the US central bank (Fed) current target of 2.0%.
Wage dynamics also look less threatening than in 2022. There is little evidence of a wage-price spiral, and wage growth for those switching jobs has slipped below job stayers – a classic sign of a cooling labour market. Therefore, we remain comfortable that over the next 12 months inflation expectations will remain anchored and consequently there is a reduced risk of sharply rising inflation becoming self-reinforcing.
Inflation Outlook 24-36 months
Looking further out, the risks that inflation surprises to the upside increase. Two significant structural forces may conspire to create a flash point:
- Deglobalization: Growth in world trade has stagnated for years. This was further aggravated during COVID when we observed the breakdown in global supply chains and the shift in trade policy to prioritizing domestic production of essential goods for the sake of industrial security. We are now witnessing a further seismic shift with the introduction of global tariffs by the US. Tariffs act like taxes on imported goods and inputs. Importers pass costs to businesses and households, lifting prices. Inflation rises initially and may persist as supply chains adjust, especially if retaliation, bottlenecks, or reduced competition amplify costs and impair productivity.
- Population aging: As baby boomers retire, they shift from net savers to dissavers. Fewer workers slow potential growth and can lift wages in tight markets, while rising demand for healthcare and services pushes specific prices higher. At the same time, older households often spend less on durable goods, thereby damping demand. As retirees dissave, real rates and inflation tend to drift upward—unless there are material gains in productivity.
The AI wildcard.
Productivity remains the swing factor. If AI delivers a material and sustainable step-up in efficiency, it could neutralize much of the stagflationary impulse by boosting supply and easing unit costs. If productivity disappoints, the structural inflation forces discussed above may dominate and bring the risk of stagflation into sharp focus for financial markets.
Conclusion.
Over the next 12 months, slower growth looks the bigger risk, while inflation expectations remain relatively subdued. Under this scenario, we suggest a balanced approach: keep share exposure but focus on steadier, cash-generating companies and look beyond exposure to U.S shares and currency. Add higher-quality bonds and increase exposure to longer-dated bonds if the market dips. Keep some real assets (infrastructure/REITs) for income and diversification, a small gold position as a shock absorber, and a healthy cash buffer for opportunities.
Looking further out, tariff impacts, demographics, and the materialisation (or not) of AI productivity gains will decide if stagflation appears. Should Stagflation become a consensus view, then conventional assets such as Shares and Bonds will likely perform poorly, and commodities and real assets (particularly those with inflation adjustment) will likely perform well.