bayarea.com
Some experts fear inflation poised for comeback
By Ken Brown
WALL STREET JOURNAL
Jim Paulsen, the chief investment officer at Wells Capital
Management, ticks off the ingredients needed for a mean batch of
inflation.
"I would flood the system with money far in excess of economic
growth, I would take interest rates to the lowest levels possible, I
would have the government spend like a banshee, I would drop
the value of the dollar, and finally I would take any capacity
growth or additional supply growth and stop it," he says. As a
garnish, he'd add rising commodity prices and a growing trade
deficit mixed with some rising trade tensions.
Sound familiar? As investors close the books on 2003 and look out
into next year, some are worrying that inflation, which had been
banished in the past few years, is poised for a comeback. Were
that to happen, it would terrify bond investors and shake up the
stock market, while giving a boon to some manufacturers, which
finally would be able to raise prices.
"Last fall we were all worried about deflation," says Paulsen.
"What could happen by summer is everyone could be panicked
about inflation."
That panic may be based more on emotion and expectations than
on anything else. There are lots of good reasons why inflation
should remain tame, mainly the lack of a strong jobs market. But
as investors spend much of their time trying to divine the future,
expectations are what will drive stocks and bonds.
If investors collectively agree that inflation is looming, the angst
will first show up in bonds, where yields will rise and prices will fall.
If the Federal Reserve shares that view, it will push up the
federal-funds rate, which is the interest on overnight loans
between banks, from its 45-year low of 1 percent.
That would drive bond prices down, causing pain for bond
investors. It could slow or stop the recent economic rebound,
which has boosted corporate profits. That means the stock market,
particularly stocks that do best in a fast-growing economy, like
industrial and big ticket consumer-goods companies, could get hit.
Paul McCulley, a managing director at bond manager Pimco, uses a
somewhat different metaphor, but also comes to an inflation
conclusion. "The cocktail now pouring into your glass is a 2.5
percent fed-funds rate by the end of 2005," he says. "The straw in
the beverage in 2004 will be fear."
McCulley, whose firm, Pacific Investment Management Co.,
oversees $304 billion in assets, predicts a bond bear market next
year -- which would come on top of a market that has been largely
weak since early this summer. The fed-fund futures market, where
investors bet on the direction of short-term interest rates, is
saying short-term rates will start their reversal in May when they
rise one-quarter of a percentage point. Other markets are
predicting inflation; investors in inflation-indexed Treasury bonds
are saying inflation will top 2.5 percent over the next several
years. That's well above the 1.5 percent rate of the past 12
months, but almost inconsequential compared to years past.
To investors who only a few months ago were wringing their
hands over deflation, all this inflation talk might seem odd. In a
way, it's a predictable part of the cycle, now that the economy has
crossed the threshold into a self-sustaining recovery. Powerful
economic data over the past few weeks have wiped away fears
that the economy might backslide into recession, though a period
of weak growth, which would keep inflation in check, is possible.
And there still are a lot of facts economists can muster to make
their low-inflation case. First and foremost is that unemployment
remains high at 6 percent, and the jobs situation is worse if you
include people who have stopped looking for work. "Inflation is a
lot like Elvis," says David Rosenberg, Merrill Lynch's chief North
American economist. "Lots of reported sightings, none confirmed."
Most experts, the Fed included, believe the economy would need
to create hundreds of thousands of jobs -- as many as 150,000 to
200,000 a month for the better part of a year -- for any inflationary
pressure to rise. But if coming jobs numbers, including Friday's
employment report come in very strong, stocks and bonds could
both tumble. |
