WHAT IS STAGFLATION?

Stagflation—a toxic cocktail of stagnating growth and rising prices—is generally viewed as a relic of the 1970s. But economists are warning it could make a comeback.

The term is broadly defined as sluggish growth tied with rising inflation. Economists haven’t given it much thought since the 1970s, when U.S. consumers lined up to fill their cars with high-price gasoline and the jobless rate hit 9%.

Earlier this week, the World Bank sharply lowered its growth forecast for the global economy this year and warned of several years of high inflation and tepid growth reminiscent of the stagflation of the 1970s.

Stagflation spells trouble for the economy. Rising inflation erodes consumer purchasing power, and weaker demand hurts companies’ profits and causes layoffs.

Stagflation also puts the Federal Reserve in a bind because the central bank’s job is to keep both inflation and unemployment low. The Fed can raise interest rates to curb inflation—a path it has started on and intends to continue this year—but if it moves too aggressively it risks strangling spending and tipping the economy into a recession.

Why is stagflation a risk now?

Inflation is close to a 40-year high, and economists are worried about economic growth because of the war in Ukraine as well as lockdowns in China and supply-chain disruptions related to the Covid-19 pandemic.

Are we in a period of stagflation now?

Not necessarily. Inflation is high, but unemployment remains near a half-century low. The U.S. economy contracted in the first quarter as supply disruptions weighed on output, but most economists expect growth will resume in the second quarter because of strength in consumer and business spending. Stagflation would be a sustained period of both higher inflation and slower growth, not just one quarter.

Stagflation remains a risk to the U.S. economy, and there are similarities between the situation in the 1970s and today. Surging prices for oil and food are pushing up the cost of living, and business executives are voicing concerns about the outlook for the economy.

But the key difference between the situation in the 1970s and today is employment. During the 1970s and early 1980s, the unemployment rate at times was around 10%. It was just 3.6% in May 2022. U.S. layoff announcements, for now, are few and far between.

What is the difference between stagflation and inflation?

Inflation refers to an increase in prices for goods and services. The Fed likes to see a bit of inflation. It targets 2% inflation a year, because that signals healthy demand in the economy. But if inflation rises too quickly, the rapid price increases erode households’ purchasing power. Stagflation is a situation in which prices are rising, but demand is weakening and economic growth is slowing or contracting. As a result, businesses make less money and cut jobs, driving up unemployment. At worst, that pushes the economy into a recession.

Has stagflation happened before?

Yes, stagflation occurred from the early 1970s to the early 1980s, when surging commodity prices and double-digit inflation collided with high unemployment.

British Parliamentarian Iain Macleod is credited with first using the word stagflation in 1965. “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of ‘stagflation’ situation.”

Its seeds were planted in the late 1960s, when President Lyndon B. Johnson revved up growth with spending on the Vietnam War and his Great Society programs. Fed Chairman William McChesney Martin, meanwhile, failed to tighten monetary policy sufficiently to rein in that growth.

In the early 1970s, President Richard Nixon, with the acquiescence of Fed Chairman Arthur Burns, tried to tame inflation by imposing controls on wage and price increases. The job became harder in 1973 after the Arab oil embargo drastically drove up energy prices, and overall inflation. Mr. Burns persistently underestimated inflation pressure: In part, he didn’t realize that the economy’s potential growth rate had fallen and that an influx of young, inexperienced baby boomers into the workforce had made it harder to get unemployment down to early-1960s levels.

As a result, even when the Fed raised rates, pushing the economy into a severe recession in 1974-75, inflation and unemployment didn’t fall back to the levels of the previous decade.

The stagflation of the 1970s ended painfully. Fed Chairman Paul Volcker drastically boosted interest rates to 20% in 1981, triggering a recession and double-digit unemployment.

Chip makers are fighting to assure investors that the artificial-intelligence boom is racing forward. Wall Street might not believe it until Nvidia’s NVDA -0.98%decrease; down pointing triangle Jensen Huang says so.

When Huang steps up to the mic for his company’s earnings call Wednesday, he will have the world’s attention. What he says about Nvidia’s present will preview the future of AI, dictate the path forward for a tech-crazed stock market and influence an American economy increasingly tethered to hopes that the boom won’t go bust.

The $5 trillion chip maker has provided the key building blocks for AI since the launch of ChatGPT in 2022 set off a race for dominance among OpenAI, Anthropic and established Silicon Valley giants. Now, as Nvidia backstops sprawling data-center projects and an exotic money pipeline to boost chip demand, the company’s influence is arguably bigger than ever.

But there are signs of trouble ahead. Political pushback to AI is growing. A bond selloff propelled borrowing costs to their highest levels in years. The hyperscalers that include some of Nvidia’s key customers—once cash-printing machines—are relying more on debt. OpenAI recently told investors its revenue rose by a tepid 18% in the second quarter while its losses deepened.

Nvidia is increasingly stepping in to shore up potential weak points across the market. Earlier this month, the company teamed up with six of Wall Street’s biggest firms on a $500 billion AI-financing plan, pledging to backstop lending to customers that can’t afford its chips otherwise. The chip maker last week also took a stake in Cloverleaf Infrastructure, which arranges power for data centers, and struck a $6 billion deal with startup Poolside aimed at developing a powerful open-weight AI model.

After watching shares in other chip makers and the so-called Magnificent Seven tech companies swing wildly in recent months, Wall Street is hoping Nvidia can beat expectations—again. The countdown is on.

“It’s kind of becoming more and more like the World Cup final than the Super Bowl at this point,” said Brian Mulberry, chief market strategist at Zacks Investment Management. “It’s just gotten to be that big.”

The company has smashed analysts’ earnings estimates for each of the 14 quarters since the AI boom kicked into high gear. Nvidia posted 210% annual growth in net income in its last three-month period, according to FactSet, making Wall Street’s 126% projection look pedestrian.

Expectations for a blowout second quarter have risen rapidly over the course of this year. All Nvidia will have to do to beat this target: outrun 95% annual earnings growth to more than $51.5 billion. Analysts project the chip maker will report record sales of $92 billion for the period, up from a forecast of $78 billion at the start of this year.

In July, big-tech earnings sparked volatility. Concerns about runaway capital spending spread across the sector after Alphabet’s and Tesla’s results, driving a $890 billion wipeout that contributed to the unwind of hedge fund Situational Awareness. Microsoft posted the largest one-day gain in market capitalization by any company, ever, after a quarter proving that it could still show investors the money. SpaceX rocketed higher after a record-breaking initial public offering, only to see $1 trillion in value evaporate.

Surging memory prices and borrowing costs have fueled fears that those and other companies will be unable to keep plowing more money into supplies including Nvidia chips. Shaia Hosseinzadeh, founder of OnyxPoint Global Management, has recently bought dips in AI-infrastructure stocks when Wall Street has strained to absorb massive debt issued by Silicon Valley.

“The macro data is really quite robust,” he said. “Of course, there’s a level at which everything breaks.”

Investors have kept pumping money into the AI trade despite concerns around chip consumers—and to the benefit of chip producers. That is why Nvidia’s outlook for semiconductor demand could send ripples through counterparts such as Micron Technology and Sandisk, developers of the data centers in which their chips reside, and a supply chain of power producers, contractors and other specialists that underpin the globe-spanning AI build-out.

“We joke internally that we’re all Nvidia analysts now,” said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management.

The irony is that investors have tended to sell Nvidia stock immediately after blockbuster earnings, with shares falling each trading session after its four past quarterly reports. Some are betting that will be the case this time around, too.

The options market is pricing in a 5.3% swing, higher or lower, in Nvidia shares during the session following earnings, according to Option Research & Technology Services. That is higher than the 4.8% average move in Nvidia’s stock over the last 12 months after the company reports quarterly results.

In recent days, some of the most actively traded Nvidia options have been put contracts tied to the stock falling from its Friday value of $214.75 to $205 and $210 apiece, according to Cboe Global Markets data. Put options give the right to sell a stock by a set price and typically represent a bearish wager.

Many analysts remain optimistic. Frank Lee, global head of tech hardware and semiconductor research at HSBC Global Investment Research, recently raised his price target for Nvidia shares to $360 from $325, citing, among other things, Nvidia’s strategic partnerships with suppliers and its role as a top contributor to open-source AI.

WHAT IS STAGFLATION?

Learn about the World Bank’s global economic outlook.

What is stagflation?

Why is stagflation a risk now?

Are we in a period of stagflation now?

What is the difference between stagflation and inflation?

Has stagflation happened before?

Nvidia’s earnings will test Wall Street’s confidence in the AI boom.