As the Iran war raises stagflation risks for the global economy, a “deep recession” may
be the only way out, says KPMG chief economist Diane Swonk.
- Stagflation
and labor-market risks are growing as the Iran war continues. - KPMG
chief economist Diane Swonk says the “only clear way out” for
the economy is a “deep recession.” - Swonk
says the Fed is in a bind because the economy is being hamstrung by
supply-side constraints.
In mentioning stagflation, Swonk is referring to a dreaded
scenario defined by persistently high inflation and sluggish growth. It can be
worse than recession, because the Federal Reserve is unable to comfortably move
interest rates in either direction.
Swonk notes the Iran war has driven multiple supply shocks
that have resulted in product shortages and higher prices. For the other side
of the stagflation equation, Swonk says the labor market is vulnerable to
rising unemployment.
“The only clear way out is a deep recession,”
Swonk wrote, noting that it’s more likely for economies outside the US, but
remains a risk for Americans.
Supply shock risks stagflation
“The closing of the Strait of Hormuz & resulting
surge in oil prices is more than an oil shock,” Swonk wrote, explaining
that the current situation is more impactful that historic oil shocks.
She noted that not only is the Strait of Hormuz a chokehold
for the global oil trade, it also sees flows of other critical economic inputs
like helium and fertilizer, among others.
As a result, costs are higher which tend to increase prices
and make companies less willing to hire, impacting employment.
“Costs are so large that they simultaneously prompt
cost-push price hikes even as firms become more reluctant to hire,” the
economist wrote.
“Involuntary layoffs rise as wages are sticky – firms
pivot to cuts in headcount as wages do not easily fall, especially amidst a
rise in prices,” she added.
The combination of forces risks stagflation.
The Fed’s sticky situation
Generally, when inflation rises or growth stalls, central
banks step in. Changes in monetary policy can help balance economic risks.
Typically, the Fed would cut rates to fuel growth and boost
employment or would raise rates to reduce inflation.
Today, the typical playbook doesn’t work because of issues
are on the supply side, not the demand side of the economy. Lower rates risk
making inflation worse, but raising rates could hurt growth.
“That will leave the Fed in a worse bind than it was in
2025, with its dual mandate of price stability & full employment in
tension,” Swonk said.
Rate hike odds rise
Investors expectations for a Fed rate cut this year have
grown, shifting away from pricing in rate cuts.
Swonk is aligned with investors on this outlook. “A
rate hike is a becoming more likely in the second half and that is what I
expect the Fed will be forced to do, along with other central banks,” she
explained.
Goldman Sachs pushed back on this idea saying that a rate
cut in 2026 is still unlikely despite investors’ expectations. – Business Insider