Stagflation at hand? Inflation, check. Stagnant growth not so much

The rise of a new coronavirus variant has raised fears of a double-barreled hit to the US economy of slowing growth and still-high inflation as supply chains stutter, local governments consider new restrictions and consumers assess the health risks of everything from dining out and traveling to returning to work.

But economists so far see the risk of "stagflation" - that toxic blend of weak growth and strong inflation so feared by policymakers - as only half-baked.

Prices are rising, in the United States more notably than elsewhere, and the pace has proved more persistent than policymakers anticipated. Growth, though, is far from stagnating, and seems on track to continue next year at an above-average pace that could push the United States to full employment in a matter of months.

Some forecasters have tempered their predictions for growth in US gross domestic product because of the new variant. But those revisions have been modest, and high-frequency data on US airline travel and metrics like restaurant visits and credit card spending so far show no obvious change in recent weeks as case counts rose and, more recently, the Omicron variant was identified.

"We are not going to see stagflation. We are going to see an inflationary boom," with strong growth continuing and the pace of price increases already prompting the Fed to reorient policy towards containing inflation, said Glenn Hubbard, chair of the Council of Economic Advisers under former President George Bush and now a Columbia University economics professor.

A Reuters poll of economists showed a median forecast of 3.9% growth for the United States in 2022, unchanged from November and about double the rate of underlying trend growth estimated by the Federal Reserve and many private forecasters. 

Federal Reserve policymakers will issue their own new forecasts next week in a meeting expected to begin more urgent preparation to assure inflation remains under control. Those forecasts will likely describe an economy nearing full employment next year and continuing to grow faster than was the norm before the pandemic.

The November unemployment rate of 4.2% is already well below the 4.8% level projected by Fed officials in September, and near the 4% rate considered sustainable over the long run.

'Booming economy'

Policymakers will also account for stronger-than-expected inflation by likely flagging faster rate increases and approving plans to end their ongoing bond purchases in March instead of June.

It is still early in the effort to understand how the Omicron variant will behave, and how people will behave as they interact with it.

If it proves faster spreading, more evasive of vaccines, and as deadly as Delta, it could trigger another wave of restrictions in some countries, and factory or travel shutdowns in others - with potentially detrimental results for global growth and jobs.

"It's just not possible for countries to redo the kind of big monetary policy push, big fiscal policy push, that they were able to do these past two years. It cannot be repeated again," International Monetary Fund Chief Economist Gita Gopinath said Thursday at an event in Geneva.

If the Omicron variant causes a new and serious economic shock, "we have the real risk of something we have avoided so far, which is stagflationary concerns."

But so far markets, analysts and economic data are not reflecting that sort of worst-case outcome.

The latest variant was first identified in early November. Since then the weekly numbers of travelers cleared onto US flights by the Transportation Security Administration has remained about the same or slightly higher in comparison with 2019, as it was earlier in the fall. In-person bookings at restaurants have also held steady, according to data from reservation site OpenTable.

A recent study by San Francisco Fed researchers noted what has become a staple hope among policymakers: that US businesses and consumers will, between the protection offered by vaccines and changes in behavior, continue to work around the virus.

"Local economic activity...was closely related to local Covid-19 conditions last year but gradually became decoupled as the pandemic wore on," the researchers wrote, with the recent Delta wave causing only a modest dip in economic activity compared to the first months of the health crisis.

"It may not feel like it given the elevated inflation environment, renewed Covid concerns and heightened market volatility, but the economy is booming," Oxford Economics Chief US Economist Gregory Daco wrote this week.

Oxford's recovery tracker, an index of combined health, economic and financial data, tumbled at the end of November, but the fall was most pronounced among financial indicators after markets took a brief hit after Thanksgiving on news of the Omicron strain. Indicators of demand and employment remained strong, and Daco has so far responded to the Omicron news with a minimal downgrade to his GDP growth outlook for 2022 - to 4.4% from 4.5%.

Goldman Sachs economists, laying out Omicron scenarios that ranged from a worst-case revival of the pandemic to a more benign outcome where the variant causes less serious illness, said they expected the ultimate hit to GDP to be modest, and lowered their 2022 forecast to 3.8% from 4.2%.

"Government policy in the US has become much less sensitive to virus spread since vaccination rates increased this spring," Goldman economists wrote, noting that their in-house index of government coronavirus restrictions barely budged during the Delta wave of infections over the summer. In addition, "consumer spending and job growth have become much less sensitive to local virus spread...likely due to lower Covid risk aversion in the US"

That will leave the Fed focused on inflation even as it watches the course of the virus, and on that front the new variant may if anything firm up the central bank's plans, Goldman's team wrote.

"We see medium and longer-term risks as mostly inflationary due to potential delays in supply chain normalization and easing of worker shortages," Goldman wrote, with a rate increase likely by mid year.