Bank of America (BofA) suggests that the current U.S. inflation levels indicate a mild stagflation, which remains favorable for risk assets. With economic issues being a key factor for the Republican Party, adjustments to policies like tariffs and immigration are expected if they harm economic growth, avoiding a repeat of severe 1970s stagflation.
Recent data shows persistent inflation above the Federal Reserve's 2% target since late 2021, despite multiple interest rate hikes. Inflation expectations have risen above 3%, with the five-year breakeven inflation rate reaching a two-year high of 2.61%.
BofA economists note that some Trump-era policies negatively impacting growth were implemented sooner than expected, while fiscal stimulus was less impactful due to the Republican's narrower House majority. Despite the slowdown, the U.S. economy is still growing at or above trend levels, with inflation remaining below 3%, which is considered positive for risk assets.
The upcoming Personal Consumption Expenditures (PCE) price index release is seen as a crucial data point for investors. The Republican Party may adjust policies if measures like tariffs significantly harm growth or increase inflation.
During the Biden administration, GDP grew at an annual rate of 3.2%, with the S&P 500 rising over 70%. To achieve similar results, Republicans need to avoid self-inflicted stagflation. The Federal Reserve is expected to adopt a less dovish stance, tightening liquidity and potentially impacting U.S. stock markets.
