Will Inflation Catch You By Surprise?

There are factors suggesting the global economy could very well be headed into an inflationary period – and sooner than some might think.

 
 

Last week, the Labor Department reported that U.S. consumer prices fell 0.1% in March, and were down 0.4% from a year ago. Commentators were quick to point out that this was the first annual decline since 1955! From the market's perspective deflation, not inflation is the order of the day.

Is that true? There are other factors suggesting the global economy could very well be headed into an inflationary period – and sooner than some might think:

  • Excessive increases in the money supply for both Europe and the United States
  • Commodity prices continuing to rise – gold prices are up 10% from January lows
  • The yield-spread between the 2-year and 10-year U.S. Treasury notes is at 1.9%, pointing to rising inflation and interest rates.

To avoid high inflation, central banks will need to raise rates – and rapidly.

Value Opportunity or Value Trap

Tom Luster, co-portfolio manager of the Eaton Vance Institutional Short-Term Income Fund describes the dilemma facing many fixed income investors in the current environment "Monetary policy is begging you to take more risk. There is no yield left for anything that is devoid of risk".

While the risk Luster describes is credit, the same line of thinking can be applied to another form of risk: interest rate. In a nutshell, all the newly printed government money, and a "stimulated" spendthrift consumer purchasing goods and services will cause inflation (prices) to skyrocket. To combat the inflation monetary policy will dictate an increase in interest rates.

While a fixed income fund manager is responsible for the total return of their bond portfolio, the credit union investment manager has that assignment, as well as the overall return of the balance sheet (not to mention the institution's primary goal of serving the membership).

Preparing for the Past

Can credit unions look to the past, at similar economic circumstances, as a way to forecast what lies ahead? What are the tactics and strategies in today's environment – in both the investment portfolio and the balance sheet – that will maintain both earnings and the net economic value of the institution?

 

 

 

April 20, 2009


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