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To: pallmer who wrote (3892)	12/10/2002 11:03:04 AM
From: pallmer	Read Replies (1) \| Respond to of 29597

-- =DJ ASSET CLASS: Is Inflation Hidden In Fears Of Deflation? -- By Alen Mattich A DOW JONES NEWSWIRES COLUMN LONDON (Dow Jones)--Amid recent warnings of imminent global deflation, a handful of pundits are starting to warn about the opposite - inflation. Commodity prices close to their highest level in five years, a massive program of interest rate cuts by central banks and signs the U.S. and other governments will throw themselves into hefty deficit spending all point to the view that price pressures could build again - and rapidly. Last week, one of the most respected of bond market gurus, Bill Gross, who heads the massive U.S. bond fund Pimco, turned cautious after having been a big bull on fixed income for the past couple of years. In the latest of his widely-read monthly notes, he argued that there are just two key questions the bond market needs to consider now: when will U.S. rates start going back up and by how much? Gross thinks that deflation and falling interest rates are yesterday's story and that the upside for bonds is limited. U.S. money market funds returning little more than 0% after fees means the Fed has little room for maneuver on this front. Instead, Gross argues that the Fed will be moved to taking special measures to prevent outright deflation. These measures - like buying long-dated bonds or other assets - have the potential to pump prime the economy so much that inflation takes off. He thinks inflation could eventually overshoot an optimal range of 2% to 3%, leaving Treasury bonds trundling along with total returns of just 4% to 5% over the next few years. Others are skeptical that inflation's a potential problem. Economists like Morgan Stanley's Stephen Roach have long argued that the huge burden of U.S. private sector indebtedness will be a big drag on any economic rebound as consumers increase savings to pay back this debt. His view is that the risks are skewed toward a double dip recession, where a lack of policy "traction" means the U.S. economy will continue to struggle. But saving isn't the only way to cut the debt burden. Inflation pulls that off by eroding the real value of borrowers' obligations. The consumer - and therefore the economy - can be saved from a deep contraction if the Fed reflates the economy. This is what some market segments seem to believe. The Commodity Research Bureau index is close to its highest levels since 1997, encouraging the view that deflation is no threat, according to Merrill Lynch strategist Michael Hartnett. The CRB futures price index is now up more than 20% from the start of 2000 and is up 12% on the start of this year. This rise in commodity prices reflects expectations of a solid economic rebound next year, according to Tom Vosa, economist at National Australia Bank. With interest rates at or near 50-year lows in most OECD countries, it's become very cheap for speculators to hold and store commodities and speculative demand has squeezed up prices, Vosa said. At the same time, factors such as the risk of war in Iraq are also underpinning oil and gold prices, he said. Commodity price gains have been mirrored by frenetic demand for growth stocks in the past two months but James Montier, a strategist at Dresdner Kleinwort Wasserstein, thinks the markets have got it wrong. He argues that while higher levels of inflation will be the eventual outcome of this process, the interim will see further deflation. He thinks such deflationary pressures are well established in the U.S. and Europe. Although they are mitigated by service-sector inflation, this merely represents a lag to the goods part of the economy. In a similar way, Japanese services were still suffering inflation for years after deflation started to work its way through the economy. Eventually services will catch up with the trend and deflation will fully grip the U.S. and continental Europe, says Montier. If Montier and Roach are to be believed, the Fed is probably too late to stave off this process. The arguments, however, seem so finely balanced that American and European monetary authorities are in the unenviable position of choosing between deflation or steep rates of inflation. -By Alen Mattich, Dow Jones Newswires; 44-20-7842-9286; alen.mattich@dowjones.com (END) Dow Jones Newswires 12-10-02 1057ET- - 10 57 AM EST 12-10-02 10-Dec-2002 15:57:00 GMT Source DJ - Dow Jones