Maybe Inflation Is More Than a Sideshow
By PAUL J. LIM
Published: October 28, 2007
BY many measures, inflation is rising — yet investors seem to be thinking less about it.
Look at the numbers: In July, consumer prices were up 2.4 percent over the same month the previous year. Gold was trading at $660 an ounce. Crude oil was hovering at around $75 a barrel. And a survey of money managers by Merrill Lynch showed that a majority on Wall Street feared that inflation would creep higher.
Fast forward to today. The most recent Labor Department inflation report, based on September data, shows the Consumer Price Index climbed 2.8 percent over the past year. Gold prices are now around $780 an ounce. Oil recently hit $90 a barrel for the first time. Yet even against this grimmer backdrop, less than a third of fund managers now think that inflation is a threat.
Of course, these fund managers aren’t alone in believing that inflation is either dead, dying or no longer a serious concern.
Even the Federal Reserve is talking less about inflation as it focuses on trying to stoke an economy that’s being pressured by ailing credit and housing markets.
This week, investors will pay particularly close attention to the Fed to see whether it will cut a key short-term interest rate for the second time in as many months — and to see whether the Fed’s views on inflation continue to evolve.
In August, the Fed made clear that it wasn’t convinced of a “sustained moderation in inflation pressures.”
But a month later, inflation went from being a front-burner issue to almost an afterthought. After its Sept. 18 meeting, the Fed said it cut rates by half a percentage point to “forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.”
And what about inflation? The central bankers indicated that “some inflation risks remain” but also pointed out that “readings on core inflation have improved modestly this year.”
This shift in language — and policy — puts the Fed “in a funny corner,” said Jeffrey L. Knight, chief investment officer of the global asset allocation team at Putnam Investments in Boston. Mr. Knight said the Fed clearly believes that it must “liquefy the credit markets” to lend support to an economy that’s slowing. “On the other hand, by doing so, they will be fanning the flames of the very risk that they purportedly were most concerned about two months ago,” he said.
To be sure, many investors and economists are convinced that inflation is under control. And a number of government statistics support this.
For instance, so-called core inflation readings, which strip out volatile food and energy prices, have been mild for some time. In fact, according to the Labor Department, core consumer prices have been growing at a seasonally adjusted annual rate of just 2.3 percent for the first nine months this year. That’s down from 2.6 percent last year.
“Inflation, despite some sharp increases in food and energy prices, has really been fairly tame on a year-over-year basis,” said Paul L. Kasriel, director of economic research at Northern Trust in Chicago.
But Michael J. Cuggino, manager of the Permanent Portfolio, a mutual fund, says we shouldn’t rely exclusively on core C.P.I. data because “in reality, businesses need energy and people need to eat.” And government data show that the costs of food and energy are going through the roof.
For example, in the first nine months this year, food and beverage prices rose at a seasonally adjusted annual rate of 5.7 percent. Transportation costs jumped at a 6 percent annual clip. For energy, the figure was even higher: nearly 12 percent.
The bottom line is that “inflation is still a risk,” Mr. Cuggino said, especially now that “there’s no longer that same level of diligence there was with respect to keeping inflation down.”
In addition to an accommodative Fed, there are a couple of reasons that investors may want to keep an eye on inflation:
RISING PRICES IN CHINA In the past few years, the United States economy has essentially been importing deflationary pressures by buying goods from China. And that’s kept overall prices in check.
But Thomas H. Atteberry, co-manager of the FPA New Income fund, notes that inflation in China has begun to soar as the economy grows and as millions of new workers a year join China’s burgeoning urban labor market.
Indeed, inflation in China was running at 6.2 percent, year over year, in September, versus 6.5 percent in August. Both figures were well above the government’s target of a 3 percent rate of inflation for 2007. “Given that we import so much from China,” Mr. Atteberry said, “this certainly doesn’t help.”
THE FALLING DOLLAR A weakening currency has always been thought to be inflationary, because consumers and businesses require more dollars to buy goods from overseas.
Ned Davis Research studied dollar declines back to 1974 and found that when the dollar has dropped more than 4.3 percent annually against a basket of foreign currencies, the Consumer Price Index has tended to accelerate by half a percentage point more than it would otherwise. Over the last 12 months, the dollar has fallen more than 10 percent against a basket of foreign currencies.
Of course, this relationship isn’t perfect. After all, the dollar has been tumbling for nearly six years, and inflation has been rather benign throughout this decade. But Gordon B. Fowler Jr., chief investment officer at Glenmede Investment Management, an institutional money manager based in Philadelphia, says that “if there’s a run on the dollar, that would be very bad for inflation.”
That brings us back to the Fed. Robert D. Arnott, chairman of Research Affiliates, an investment management firm in Pasadena, Calif., says the Fed is “caught between a rock and a hard place.” If the Fed leaves rates alone, he said, it “risks the markets cratering and the economy going from slowdown to possible recession.” But if it lowers rates again, he said, “the dollar would be at further risk.”
And that could prompt more inflation, which would be just as bad for the economy.
Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com. |
