Investing Insights

STAGFLATION WATCH  •  May 19, 2025  •  Jon Wolfenbarger

Here’s Why Inflation Will Accelerate And Housing Will Weaken

LISBON, PORTUGAL — “Stagflation”. i.e., high inflation and a weak economy, is the worst nightmare of Jay “Transitory Inflation” Powell and his fellow bureaucrats of the Fed. That is because their monetary policy ”tools” will not work to cure stagflation. If they tighten monetary policy to fight inflation, they will weaken the economy further. And if they ease monetary policy to stimulate the economy, they will fuel higher inflation, which will force them to tighten. Then the Fed will know what it is like to be between a rock and a hard place, kind of like how American consumers feel now due to the Fed’s boom-bust policies.

Unfortunately, the latest coincident and leading economic data shows that stagflation is exactly what we and the Fed are facing.

Inflation Remains Stubbornly High…

As the chart below shows, consumer price inflation (CPI; blue line) ticked down from 2.4% in March to 2.3% in April. But Core CPI (ex food and energy; red line) held steady at 2.8%, which is 40% higher than the Fed’s 2% target. SuperCore CPI (services inflation ex food, energy and shelter; green line) also held steady at 3.3%. Unfortunately, that is 65% higher than the Fed’s target and even higher than the levels seen in mid-2023.

On a more encouraging note, producer price inflation (PPI; blue line) slowed significantly from 3.4% to 2.4%, although that is still slightly above CPI at 2.3% (red line).

And Is Likely To Accelerate

But that is past inflation data. The more important question is about the future: what will inflation data look like going forward?

To try to answer that, let’s look at some leading inflation data.

The latest Philly Fed manufacturing survey said 86% of manufacturing firms expect their competitors to raise their prices in response to tariffs with about a two month delay. The chart below shows that the Prices Paid indexes of the regional PMIs is spiking to historically high levels and these indexes lead consumer price inflation by about three months. Thus, odds are high that inflation will accelerate in coming months. That will make it very difficult for the Fed to cut rates and it may even force them to raise rates. How will the stock market, commodities and cryptocurrencies react to that? We do not think they will react in a bullish manner, to say the least.

In addition, the latest University of Michigan consumer survey showed 12-month inflation expectations jumped to 7.3%, which is the highest level since 1981. While that level is hard to believe right now, the fact that consumers expect higher inflation suggests that they will lower their demand to hold cash, which will contribute to higher inflation going forward. This will likely happen, unless Trump gives up all his plans for tariffs, which is hard to imagine since that is the key to his entire economic program, or the Fed hikes rates aggressively, which is the last thing the Fed wants to do given high Federal debt levels and interest expenses.

Housing Recession Worsens

The chart below shows housing starts (blue line) and housing permits (red line) continue to be weak.

But that is past housing data. As with inflation, the more important question is: what will housing data look like going forward?

To try to answer that, let’s look at some leading housing data.

The NAHB/Wells Fargo Housing Market Index (HMI) is a home builder survey that is very helpful for telling us the likely direction of housing demand going forward. Unfortunately, the HMI fell from 40 in April to 34 in May, the lowest reading since December 2022 and well below the neutral 50 level, as shown below. 

The current sales conditions index fell from 45 to 37, the sales expectations in the next six months index fell from 43 to 42 and traffic of prospective buyers fell from 25 to an abysmal 23. Trump’s ongoing trade war is not helping, as it has caused 78% of home builders to say they are having difficulties pricing homes due to uncertainty about material prices.

NAHB Chairman Buddy Hughes explained the latest survey and noted that most of the survey was conducted before the announcement of the US-China tariff agreement:

“The spring home buying season has gotten off to a slow start as persistent elevated interest rates, policy uncertainty and building material cost factors hurt builder sentiment in May. However, the overwhelming majority of survey responses came before the tariff reduction announcement with China. Builders expect future trade negotiations and progress on tax policy will help stabilize the economic outlook and strengthen housing demand."

Regardless of tariffs, the biggest problem for housing demand continues to be low affordability due to high prices and high interest rates. This chart shows the average home requires about $120,000 of housing income to not spend more than 30% of income housing. That is about 50% higher than actual household income of around $80,000.

Investment Implications

The latest economic data shows inflation remains stubbornly high and is likely to accelerate going forward due to tariffs and rising inflation expectations. it also shows that housing demand is in a recession and is likely to worsen going forward. 

What will the Fed to about this? What will Trump do? What will investors do? 

Our guess can be summarized in one word: panic.

Thus, we believe a lot more volatility lies ahead for financial markets.