①Diane Swonk, Chief Economist at KPMG, warned that the US-Iran war has heightened the risk of global economic stagflation, and a 'deep recession' may be the only way out; ②Stagflation refers to persistently high inflation coupled with sluggish economic growth, which the Federal Reserve cannot easily address through interest rate adjustments.
Cailian Press, April 3 (Editor Huang Junzhi) The US-Iran war, which has lasted for more than a month, has exacerbated the risk of global economic stagflation. Diane Swonk, Chief Economist of KPMG, one of the Big Four global accounting firms, stated that if this situation indeed occurs, a 'deep recession' might be the only solution.
Stagflation means persistently high inflation accompanied by weak economic growth. This scenario is far worse than an economic recession because the Federal Reserve cannot adjust interest rates as easily.
Swonk pointed out that the Iran war has triggered multiple supply shocks, leading to product shortages and rising prices. On the other hand, labor markets are also vulnerable to rising unemployment rates, which exacerbates the stagflation situation.
If the economy falls into stagflation, she warned that 'the only way out would be a deep recession.' She noted that while this scenario is more likely to occur in economies outside the United States, it still poses a risk for Americans.
Supply Shocks and Stagflation
Swonk wrote, 'The closure of the Strait of Hormuz and the resulting spike in oil prices is not merely an oil shock,' explaining that the current situation has a greater impact than any previous oil shock in history.
She noted that the Strait of Hormuz is not only a vital passage for global oil trade but also a channel for the flow of other critical economic inputs such as helium and fertilizers. As a result, rising costs often lead to higher prices and make companies less willing to hire employees, affecting employment.
This economist wrote, 'The costs are so high that they have led to cost-push price increases while making businesses increasingly reluctant to hire.'
'Given the stickiness of wages, involuntary layoffs will increase. In other words, since wages do not decline easily, especially amidst rising prices, businesses will resort to layoffs. The combination of these factors could lead to stagflation,' she added.
The Federal Reserve Faces a Dilemma
Typically, when inflation intensifies or economic growth stagnates, central banks intervene. Adjustments in monetary policy help balance economic risks. The Federal Reserve can lower interest rates to stimulate economic growth and promote employment, or raise interest rates to reduce inflation.
However, Swonk pointed out that traditional response strategies are no longer effective because the problem lies in the supply side of the economy, rather than the demand side. Lowering interest rates could exacerbate inflation, while raising them might harm economic growth.
"This will make the Federal Reserve's situation even more challenging than in 2025, as its dual mandate of price stability and full employment comes under pressure," she added.
Probability of Rate Hikes Rises
As the U.S.-Iran conflict has unfolded, it is clear that most investors no longer expect rate cuts this year. In fact, since the outbreak of the war, markets have priced in about a 45% probability of the Federal Reserve raising interest rates by the end of 2026, compared with only 12% before the Middle East conflict erupted.
Swonk shares a similar view with investors, stating, "The likelihood of a rate hike in the second half of the year is increasing. I expect the Federal Reserve and other central banks will be forced to act accordingly."
Nevertheless, optimistic voices like Goldman Sachs believe that the market has overestimated the risk of Federal Reserve rate hikes. They still maintain that the Fed may cut rates within the year.
Editor/Rocky