Fed hikes could lead to stagflation, investors worried

A growing number of economists and money managers are alarming about the possibility of a return to 1970 stagflation, as the Federal ReserveFederal Reserve moves to tame sky-high inflation.

According to a recent survey from Bank of America Global Research, a majority of investment fund managers now view below-trend growth and above-trend inflation as the most likely outcome for the economy over the next year.

The combination of economic stagnation and high inflation is characterized by soaring consumer prices as well as high unemployment. In the 1970 s and early 1980s, the phenomenon ravaged the U.S. economy, as rising unemployment and easy monetary policy pushed the consumer price index as high as 14.8% in 1980, forcing Fed policymakers to raise interest rates to nearly 20% that year.

Although investors believe that inflation has peaked in the U.S., they are still piling up cash on worries that economic growth could be slowing. The highest level since September 2001 was reached in May by the cash levels at 6.1%, according to the survey. It's up from 5.5% in April.

Consumer prices jumped 8.3% on an annual basis in April, close to a 40 year high, and are expected to remain elevated in the coming months. The Fed has gone on its most aggressive course to tighten policy in decades, raising rates by a half-point earlier this month and signalling that similarly sized hikes are on the table at coming meetings.

There are growing fears that the Fed will trigger a recession because hiking interest rates tend to cause higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending. Wall Street firms think that there will be a downturn in the next two years, as well as Fannie Mae and Deutsche Bank.

Powell acknowledged that there could be some pain associated with reducing inflation and curbing demand, but pushed back against the idea of an imminent recession, identifying the labor market and strong consumer spending as bright spots in the economy. He warned that a soft landing is not assured, the sweet spot between cooling demand without crushing it and triggering a recession.

It won't be easy to do and it will be challenging. No one here thinks it will be easy. There are paths, but we think there are. Powell said it was important for us to get there in a recent interview with Marketplace.