Position For The Tail Risk Of 'Stagflation' - BofA Merrill

Despite Federal Reserve Chair Janet Yellen’s cautious tone on price data, our economists expect a steady uptrend in inflation and see a strong argument for the Fed to overshoot the 2% inflation target.

At the same time, our big data leading indicator continues to show negative momentum and predicts below-consensus US GDP growth for 1Q and 2Q.

While it is not our base case, investors may want to hedge the tail risk of the economy experiencing elements of stagflationrealized as rising inflation during stagnating growth.

Our analysis shows that during historical stagflation episodes, US Treasuries and commodities tend to outperform, while equities tend to underperform. The impact on currencies is more muted with some bias for USD weakness.

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