September 2013 Index
December 5, 2013
U.S. Energy Production Helps Keep Inflation Under Fed Targets
Inflation in the U.S. has been ticking lower recently in large part to a decline in domestic U.S. energy prices. October’s Consumer Price Index data from the Bureau of Labor Statistics showed a 1 percent increase in the prices of items in their basket The prices of basic, essential needs tracked in our Guild Basic Needs IndexTM — which includes certain food, clothing, shelter, and energy components — actually showed a year over year decline of 2.9 percent. The low inflation has given the Federal Reserve a green light to continue their extraordinary monetary stimulus of bond purchases and near zero percent interest rates. It is no secret that the QE program will be scaled back, but thus far the signals from the central bank suggest that they prefer a 2 percent inflation rate and a 6.5 percent unemployment rate before they remove their QE accommodation.
Perhaps the Fed’s Targets Are Not So Far Out Into the Future…
U.S. economic data continue to improve, and we expect GDP to keep rising throughout 2014. It is GIM’s view that this is the stage of the economic cycle where corporate boards start to spend to expand their factories and to hire more employees.
Our vies is increasingly supported by economic data on employment, capital spending, etc. We expect to see an upward revision of Q3 U.S. GDP and expect good GDP growth over the next several quarters.
Of interest to investors, the bond market is already sending signals that interest rates will rise. Interest rate increases are normal and expected when economy grows. Historically, interest rates pm 10-year U.S. treasury bonds have usually been at least 3.3 percent above the 1-year bond rate. One year bonds pay about 0.1 percent, so it would not be surprising to see 10-year bonds yielding 3.4 percent up from 2.8 percent today.
Today, bond yields are moving higher for two reasons: first, a strengthening economy, and second, an eventual reduction in Federal Reserve bond buying. Interestingly, all of this is taking place while inflation is relatively quiescent.
After decades of declining rates, we are confident in our view that interest rates are in the beginning stages of a long-term move higher. The average yield for the 10-year treasury is much higher than the current 2.84 percent. We see 3.75 percent as a reasonable target for 2014. The pace of the rise –whether it is steady, volatile, or accelerating — is of particular importance to investors. Slow and steady increases in interest rates that are combined with increases in economic activity can be supportive of the equity markets. However, rapidly rising interest rates that exceed the pace of economic growth are not constructive for markets.
Decades of experience watching markets tells us that the longer term driver of interest rates is not the Fed’s bond-buying program, but global expectations for economic growth and future inflation. It is possible that the third quarter of 2013 was the low point for inflation data, and that prices of goods and commodities could begin to march higher. We are watching these developments closely and will share our analysis with you.
November 21, 2013
Jobs That Aren’t Coming Back
Unemployment has remained stubbornly high during the recovery that has followed the Great Recession. This high unemployment, as we noted above, is a fundamental concern of the incoming chief of the Federal Reserve, to the point where the Fed’s dual mandate — maximal employment and stable prices — seems at least rhetorically to be tipping decisively in favor of labor. Janet Yellen is not alone among economists in giving particular attention to the long-term unemployed and the potentially severe social consequences of their plight.
November 7, 2013
Global Inflation: A Mixed Picture
Many investors and global macro economists have been on vigil for a ramp up in global inflation spurred by immense central bank QE and other forms of monetary stimulus. All of the money printing from around the globe has helped keep the financial system functioning, and it continues to help weak developed economies get back on firmer growth footing. However, it has not translated to rapidly rising prices for goods and services that many expected. Yes, there have been pockets of high inflation, especially in developing markets (often related to food and energy items), but when you have had these price spikes, they haven’t lasted. In fact, many commodities have been trading near the lows of the past three years.
Macro Forces At Work Keeping Inflation Under Wraps — For Now
At some point, we expect global prices of goods and services to accelerate, but as long as there are powerful forces working against the monetary debasement, inflation has been delayed. Some of the forces holding prices down include a de-leveraging of banking systems following the financial crisis, labor slack in the developed world, relatively good crops, rapidly increasing energy production in North America, and a slowing rate of growth in China. This has led to the mixed bag of inflation numbers.
Speaking of the U.S., A Dovish Central Bank Seems Committed to Higher Inflation
Federal Reserve policy makers meet this week and one of the things they will discuss is that inflation is not rising fast enough. Some economists within the Fed are convinced that more inflation will go a long way towards helping the economy escape from a half-decade of sluggish growth, low wages, and high unemployment. Inflation bottomed in 2009 at about 0 percent, but is now mired in the low to mid 1’s according to the Consumer Price Index (CPI), well below the central bank’s target of +2 percent.
Janet Yellen, President Obama’s nominee to lead the Fed starting next year, is among the Fed economists to argue that a little more inflation is particularly valuable when the economy is weak, as it can help improve wages, help borrowers repay debts, and give companies some pricing power. Inflation has also typically encouraged people and businesses to borrow and spend, which is needed to spur the moribund economy. It’s not just the Fed that believes in a prescription of higher prices. Other influential economists are calling for more inflation-inducing action. Harvard economist Kenneth S. Rogoff, wrote recently that “Weighed against the political, social and economic risks of continued slow growth after a once-in-a-century financial crisis, a sustained burst of moderate inflation is not something to worry about — it should be embraced.” Professor Rogoff even suggested that the Fed is not being aggressive enough. He says that inflation should be pushed as high as 6 percent a year for a few years.
To the monetary hawks, this sounds blasphemous. They warn that the Fed could lose control of prices as the economy recovers. As inflation accelerates, the benefits can quickly be overcome by consequences of people hoarding and rushing to spend money. High inflation is particularly tough on the poor and on retirees living on fixed incomes; not to mention the fact that it can lead to more speculation and less lending and long-term investing. The hawks argue that inflation is already a problem, and they cite that over the past 10 years gasoline prices are up over 121 percent. Healthcare is up 81 percent; college costs are up 61 percent, and milk is up 29 percent.
Nonetheless, CPI remains tame, and the hawks seem to be outnumbered by the doves.
Watch the Guild Basic Needs IndexTM For Signs That Inflation Is Back
As our regular readers know, in 2012, we started the Guild Basic Needs IndexTM. Our index tracks the prices of four categories of primary and essential living needs: Food, Clothing, Shelter, and Energy (that is needed for basic heating, electricity, cooking, and transportation). We suspect that inflation will show up in these items before it shows up in the CPI data. This can give investors an early look into what is percolating below the surface. Since the start of 2000, our GBNI of basic, essential needs has risen over 85 percent, while the CPI is up less than 40 percent.