Despite his peers sounding the alarm about the potential for a U.S. recession for over two years now, Ed Yardeni, founder and chief investment strategist at Yardeni Research, has remained steadfastly bullish. The veteran market watcher, who spent decades in various prestigious Wall Street positions and previously served as a Federal Reserve Bank economist, has long argued that the odds of a “hard landing” for the U.S. economy are relatively low due to fading inflation and a strong labor market.
But on Monday, Yardeni revealed that the rapid rise in oil prices this summer has raised the prospect of a 1970s-style era of persistent inflation and a recession.
Brent crude oil prices, the international benchmark, have risen 30% to over $94 per barrel since June 27 amid consistent OPEC+ and Russian crude production cuts, leading to a more than 8% jump in U.S. retail gasoline prices over the same period. While the current $3.88 national average price for a gallon of gasoline remains well below its $5 June 2022 peak, Yardeni argued in a Monday note that the rising prices are “a concern.”
“If the price of oil breaches $100 per barrel and the price of gasoline rises solidly above $4.00 a gallon and both remain above those levels for a while, they could trigger a renewed wage-price spiral and higher inflationary expectations,” he warned.
A wage-price spiral occurs when workers demand wage increases to preserve their incomes during periods of inflation. This ultimately increases costs for businesses, which then raise prices to compensate, the theory goes, leading to spiraling inflation that can be difficult to tame.
“That scenario would be reminiscent of the 1970s,” Yardeni explained, quickly adding that this “is not the scenario we consider most likely, but it is the risk to our happier outlook.”
Because of the risk of returning to high inflation—as well as several other recent developments including the widening Federal budget deficit, the United Auto Workers’ (UAW) strike, and a potential government shutdown this month—Yardeni now believes the odds of a U.S. recession by the end of 2024 are 25%, up from his previous prediction of 15%.
Yardeni’s forecast clashes with that of Goldman Sachs, which lowered its recession odds to the historical average of 15%, from 25%, at the beginning of the month. Instead of warning signs, Goldman Sachs sees economic data that indicates low odds of a serious downturn.
“The continued positive inflation and labor market news has led us to cut our estimated 12-month U.S. recession probability further,” the investment banks’ chief economist Jan Hatzius wrote in a note to clients.
Another era of guns and butter?
In his Monday note, Yardeni, who has also taught at Columbia University’s Graduate School of Business, outlined the similarities and differences between the inflationary 1970s and the 2020s, arguing that another era of sustained inflation is a severe risk to the U.S. economy—even if it’s an unlikely one.
First and foremost, he highlighted how the federal government’s policies are beginning to mirror the “guns and butter” approach of President Lyndon Johnson that laid the groundwork for the Great Inflation of the 70s and early 80s, when the consumer price index spiked as high as 14%.
In the late 60’s, Johnson decided to finance the Vietnam War and his Great Society programs—including Medicaid and the National Endowment for the Arts—through deficit spending, leading inflation to rise, according to Yardeni. Now, we are replicating a milder version of that scenario after years of pandemic relief and Ukraine War spending as well as the passage of the CHIPS and Science Act and the Infrastructure Investment and Jobs Act that come with $280 billion and $1.2 trillion price tags, respectively.
Yardeni said that fiscal policy is unlikely to do the same amount of damage it did in the 70s, however. He pointed to the healthy labor market and the strength of the U.S. dollar, which has helped keep commodity prices from spiking as dramatically as they did in that era, and argued that the Federal Reserve has been more aggressive raising interest rates to tame inflation.
Rising oil prices
Another major similarity between the 1970s and the 2020s has been consistently rising oil prices due to wars.
“We have no doubt that the Great Inflation of the 1970s was caused by the two spikes in the price of oil during 1973/74 and again in 1979, both triggered by wars in the Middle East,” Yardeni explained, noting that oil prices jumped 213% and 166% respectively during these two periods, sparking two U.S. recessions.
However, although the war in Ukraine also led to a 46% oil price spike in the first half of 2022, the milder jump didn’t trigger a recession. And Yardeni said that—unless another geopolitical crisis unfolds in the Middle East, leading to a spike in oil prices—the nearly 20% jump in crude prices so far this year “isn’t likely to cause a recession either.”
Wages and union contracts
Finally, both in the 1970s and the 2020’s workers demanded pay increases to match rising inflation. In the Great Inflation era, the powerful Teamsters union, which represents truck drivers, was able to negotiate substantial pay raises for its members. And postal workers went on strike in 1970 and formed a more robust union of their own, forcing the federal government to eventually offer them multiple pay hikes as well.
The strength of the labor movement ultimately kept wage inflation elevated, helping produce the sustained rise in consumer prices seen during that era, according to Yardeni, who argues the current rise of unions may exacerbate inflation in the same way today.
“Today’s unions have been energized by stagnating real wages. They’ve achieved sizeable compensation gains in recent negotiations,” he said, referencing the recent United Auto Workers strike and UPS union deal that included pay raises.
However, Yardeni also explained that union members make up a much smaller percentage of the labor force than they once did, which should help prevent the dramatic wage-price spiral of the 70s. Union membership is down to 6% in private sector employment, from 16.8% in 1983.
Productivity and technology
While the similarities between the 1970s and today are striking, productivity growth may save the U.S. economy from a repeat of history. By the end of the Great Inflation, in the early 1980s, productivity growth had plunged to a record low, but Yardeni doesn’t see that happening this time around.
“We expect to see the plethora of technological innovations boosting productivity in many more companies in many more industries than ever before. In this sense, all companies are now technology companies,” he said.
Yardeni believes annual productivity growth—which came in at just 1.6% during the second quarter of this year—will resume its upward trend toward 4% later this year and inflation caused by increased wages will “moderate,” enabling the Federal Reserve to end its rate hiking campaign. And unless there is an unexpected oil supply disruption in the Middle East, he doesn’t expect the current crude price spike to continue. That means there is unlikely to be a “second peak for inflation” like there was in the 1970s that would force the Fed to raise interest rates until they cause a recession.
“The recent rise in the price of oil is somewhat reminiscent of what happened during the Great Inflation of the 1970s. So is the push by labor unions for higher wages to offset the rapid rise in the cost of living. Nevertheless, we don’t expect a replay of the 1970s,” Yardeni concluded.