Inflation rates—a general increase in prices–are very low. With Fed officials talking openly about low inflation and the risk of deflation, it is appropriate to examine inflation risk and how to address it. High levels of inflation erode purchasing power and the value of stocks and bonds.
This week we review aspects of inflation. The first article from the front page of the New York Times reports that economists, both inside and outside the Fed, are discussing inflation in favorable terms. The next two articles discuss portfolio positioning when inflation is expected.
In Fed and Out, Many Now Think Inflation Helps. Janet Yellen, President Obama’s nominee to lead the Fed starting next year, has argued, along with other economists, that a little inflation is particularly valuable when the economy is weak, according to the New York Times. “By one measure, inflation rose at an annual pace of 1.2 percent in August, just above the lowest pace on record.” The Fed has tried since the financial crisis to keep prices rising about 2 percent a year. “All this talk has promoted dismay among economists who see little benefit in inflation, and who warn that the Fed could lose control of prices as the economy recovers.”
Rob Arnott, head of Research Affiliates, shares his firm’s market insights and allocation strategies. Arnott notes that real economic recovery is a ways off, but the longer-term view of inflation risk is on the upside, and he offers an asset allocation solution. “Mainstream stocks and bonds excel in a disinflationary world…those first two pillars need to be complemented by a ‘third pillar’—those that diversify away from mainstream stocks and bonds, provide higher yield, higher growth or both, and offer the potential for better returns in the face of rising inflation…alternative strategies are becoming more attractive over time.”
Survival of the Fittest? Bill Gross of Pimco offers his viewpoint that the Federal Reserve won’t be raising short-term rates until 2016 or beyond. “Because of the inflationary intention of low policy rates