July 2013 Index

August 22, 2013

Are Interest Rate Increases Signaling Higher Inflation on the Horizon?

Since bottoming in 2012, U.S. interest rates have been rising — the exception being short-term interest rates, which are set by the Federal Reserve. There are a few key reasons for the rise in rates. The most often cited reason is the feared end of QE by the Federal Reserve. If the Fed stops buying bonds, who else will fund the U.S. government. The bottom line is that after declining for 32 years, interest rates got too low, and now the interest rate that investors require to buy bonds maturing in three years or more have gone up significantly…and look like they are headed higher still. Another reason for the rise is the fact that investors believe the low returns on bonds in recent years are not enough to protect their principal from the purchasing power decline that comes from a rising cost of living. This is not just a U.S. phenomenon.

The rapidly rising U.S. interest rates are having important effects on world markets; one of them is the sudden decline in certain emerging market currencies. India, Brazil, Turkey, Indonesia, and other countries have seen their currencies slide in recent weeks. Central banks are acting to slow currency declines to fend off uncomfortable increases in inflation that result. Inflation can be hard to contain and can spill across national or regional borders.

Last year and earlier this year, we wrote about how inflation around the globe had moderated. However, it appears that this trend may be coming to an end. While not yet high in the developed world, price increases in the developing world should be closely monitored to see when they will arrive on our shores. For example, food commodities rising in price in India due to poor rainfall during the annual monsoon will effect the price of food commodities on the other side of the world. This is one reason we are watching the prices of certain basic needs closely and are tracking them here, in our Guild Basic Needs IndexTM (GBNI) to see if and when price changes abroad spill over into the U.S.