Muzinich Weekly Market Comment: The looming shadow of stagflation

March 31, 2025

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In our latest roundup of the key developments in financial markets and economies, we look at the implications of a worrying deterioration of consumer spending.

Government bond curves bull-flattened last week, while US corporate credit continued to underperform. In contrast, European investment-grade credit acted as a relative safe haven, generating a positive total return, while emerging market credit stood out in the high-yield segment.

The Japanese yen was the weakest-performing currency due to inflationary concerns. Commodity prices drifted higher, with silver leading the way. Equities were soft across the board, with the Bloomberg World Large & Mid Cap Index down around 1.2% for the week.

Consumer crunch

For economists and investors, it was an opportune moment to assess the evolution of consumer prices. In Japan, the Tokyo Consumer Price Index, widely viewed as a leading indicator of nationwide inflation, increased 2.9% in February.^[1] Consumer prices excluding fresh food increased 2.4% year-on-year, surpassing the median forecast of 2.2%.

The report provides further evidence that underlying inflation has reached the Bank of Japan's (BOJ) 2% target, potentially giving the central bank a green light to tighten policy further. However, the timing of the next adjustment is clouded by the uncertainty surrounding tariffs, with Bank of Japan Governor Kazuo Ueda favouring a "wait-and-see" approach.

In contrast, UK consumer price inflation unexpectedly dropped to 2.8%,^[2] below consensus forecasts, keeping the Bank of England (BOE) on course for a quarterly rate cut in May. The main surprise came from core goods prices, which rose at an annual pace of 1.1%, down from 1.6% in January. Meanwhile, services inflation, a key metric for the BOE, held steady at 5%, slightly below the central bank's own projection of 5.1%.

This should be good news for beleaguered UK Chancellor Rachel Reeves, as the combination of higher real income and lower policy rates could help stimulate the UK’s sluggish economy. At her Spring Statement speech last week, Reeves did the bare minimum to preserve her credibility with markets by restoring her fiscal buffer to its October level.^[3] Faced with a £14 billion deterioration in public finances, she cut spending, trimmed welfare, and tackled tax avoidance.⁴

These measures brought the margin against her fiscal rule — which requires taxes to fund day-to-day spending — back to £9.9 billion, the third smallest level on record. However, the Office for Budget Responsibility (OBR) puts her chances of missing that rule at 46%, a reflection of the limited room for error. With the margin representing less than 1% of total government spending, it could easily be eroded before her autumn budget, especially in the uncertain current global climate.

In the US, analysts scrutinized the latest official reports to gauge how consumers are responding to the new administration. The data painted a concerning picture, highlighting the predicament facing the Federal Reserve.

US consumer spending is slowing this year. On a real basis, it increased just 0.1% month-over-month in February, compared to a 0.6% decline in January, translating into a 0.2% pullback for the first two months.^[5] This marks a sharp deceleration from the 4% spending growth seen in Q4.

US consumer spending accounts for approximately 68-70% of GDP,^[6] making this slowdown particularly significant. In February, Americans reduced spending on services for the first time in three years, weighed down by rising prices. This was reflected in the Fed’s preferred inflation gauge, the core Personal Consumption Expenditures Price Index (PCE), which rose 0.4% month-over-month, surpassing expectations. It is now running at more than twice the speed needed for the Federal Reserve to achieve its 2% inflation target, with February's price increases pushing annual core PCE inflation to 2.8%, up from 2.7% in January.^[7]

The worst of both worlds

Stagflation is a rare economic condition characterized by slow growth, rising inflation, and higher unemployment. A supply shock is widely considered the most common root cause of this phenomenon.

In 1973, OPEC imposed an oil embargo, sending prices soaring and triggering stagflation. The question is, could the US administration's hostile tariff policies create similar conditions? The evidence is mounting, as seen in last week’s economic data and the latest round of tariff announcements.

Last week, the Trump administration prepared industries for impending copper tariffs,^[8] despite the US facing a significant copper supply deficit. The US gets 44% of its copper from foreign producers. Year-to-date, copper prices have already risen by 12%.⁹

In addition, President Trump signed an executive order imposing a 25% tariff on all imported passenger vehicles, light trucks, and certain auto parts, effective April 3.^[10] These tariffs are expected to disrupt global supply chains, with the most immediate impact on original equipment manufacturer production. Over time, as pricing power returns, the inflationary effects on new cars could also trickle down to the used car market. While reshoring may offer a potential solution, labour availability — particularly given the administration’s stance on immigration — remains a significant challenge.

Past performance is not a reliable indicator of current or future results.

References

[1] Statistics Bureau of Japan, Tokyo CPI, March 28, 2025
[2] Office for National Statistics, Inflation and price indices, March 26, 2025
[3] GOV.UK, Spring Statement 2025 speech, March 26, 2025
[4] Bloomberg, 'Reeves risks Autumn tax hikes,' March 26, 2025
[5] US Bureau of Economic Analysis, Personal Income and Outlays, March 28, 2025
[6] Federal Reserve Bank of St Louis, Shares of gross domestic product: Personal consumption expenditures, March 27, 2028
[7] US Bureau of Economic Analysis, Personal Consumption Expenditures Price Index, March 28, 2025
[8] Bloomberg, ‘Trump Weighs Imposing Copper Import Tariffs in Weeks, Not Months,’ March 26, 2025
[9] MarketWatch, 'Why copper may be more important to the U.S. economy than oil,' March 26, 2025
[10] The White House, Fact Sheet: President Donald J. Trump Adjusts Imports of Automobiles and Automobile Parts into the United States, March 26, 2025

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies are for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of March 31, 2025, and may change without notice. All data figures are from Bloomberg, as of March 28, 2025, unless otherwise stated.

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