Introduction to Stagflation
The US economy is facing a potential worst-case scenario in 2026, with a looming threat of stagflation. Stagflation is a rare economic condition where the economy experiences stagnant economic growth, high inflation, and high unemployment. According to economists at RBC, the US economy is increasingly on track for a "stagflation lite" scenario in 2026, characterized by below-trend growth and uncomfortably high inflation.
Factors Contributing to Stagflation
Several factors are contributing to the potential stagflation scenario in 2026. These include:
High Housing Costs
High housing costs are a key pressure propping up core services inflation. The measure of inflation, which excludes goods and volatile food and energy prices, is running at around 3.5% year-over-year. Home prices have risen significantly over the last five years and are still increasing, with home values rising 1.3% year-over-year in September. The owners’ equivalent rent of residences in the average US city also rose 3.7% year-over-year in September.
Sticky Wage Growth
Sticky wage inflation is also keeping inflation propped up. The average hourly earnings of all employees in the private sector grew 3.8% year-over-year in September. Core services inflation, minus housing costs, hasn’t turned negative in the last forty years, largely due to upward pressure from wages.
Tariffs
Goods prices are also expected to contribute to inflation, with goods inflation steadily increasing over the past year. The introduction of reciprocal tariffs by President Donald Trump is expected to continue to stoke goods inflation. RBC economists believe that tariffs will weigh on the labor market and put upward pressure on inflation, with the full passthrough of tariffs to consumer goods prices expected to peak in Q2 2026.
Heavy Government Spending
Heavy government spending is another factor that could keep a lid on economic growth next year. Government spending is often thought to stimulate the economy, but it could also hinder growth in the medium term, as higher spending in the public sector is often associated with lower productivity. The US is on track to run a $21.1 trillion deficit over the next decade, according to a projection published by the Congressional Budget Office.
Implications of Stagflation
The potential stagflation scenario in 2026 has significant implications for the US economy. Stagflation is often harder for the Fed to resolve than a typical recession, as higher inflation prevents the central bank from cutting interest rates to stimulate the economy. The combination of high inflation, stagnant economic growth, and high unemployment could lead to a difficult economic environment in 2026.
Conclusion
In conclusion, the US economy is facing a potential worst-case scenario in 2026, with a looming threat of stagflation. High housing costs, sticky wage growth, tariffs, and heavy government spending are all contributing to the potential stagflation scenario. The implications of stagflation are significant, and the Fed will need to carefully navigate the economic environment in 2026 to mitigate its effects. As the economy heads into 2026, it is essential to monitor these factors and be prepared for the potential challenges that lie ahead.
