The Fed, Inflation expectations and real estate
Posted: January 28, 2010 by John McClelland
Recent remarks by the Federal Reserve suggest that they believe that inflation is likely to be subdued for some time. The committee stated yesterday that they will continue the target range for federal funds at 0 to ¼ percent. Naturally, since not all indicators point to a full economic rebound, the Fed has to be careful not to prematurely apply the brakes.
However not everyone in the world markets has this same view on inflation expectations. Many bond traders have the view that inflation will not be subdued in the coming years. Many observers prefer to use gold as an indicator of inflation and gold recently hit highs in several currencies, especially the dollar.
In an recent article in the Wall Street Journal, Tom Lauricella notes that investors do not believe that the Fed will be able to reverse its giant money infusion without instigating inflation. He describes that Treasury Inflation Protected Securities (TIPS) are a good measure of gauging investor’s inflation expectations. Nice readings can also be obtained from the 5yr5yr breakeven which employs the 10-year TIPS to guess about inflation 10 years hence. An excerpt from the article:
Barclays Capital's 5yr5yr measure now reads 2.9% a on a par with levels in late 2003. Then, "these measures increased because the Fed was keeping rates low" as it's doing now, says Michael Pond, inflation market strategist at Barclays.
What's causing this? Not expectations of rapid economic growth. "Investors appear to be concerned that the Fed may not have the right tools to put quantitative easing into reverse or get the timing right," says Jeffrey Schoenfeld, co-head of fixed income at Brown Brothers Harriman.
Still a tough call on inflation and it really depends on the strength of the rebound because we do have flat or declining prices on a lot of things people use, especially housing. Further, I see hidden inflation in many products. Have you bought a candy bar or some other food goods lately? I think they’ve gotten smaller. I also notice poorer quality in a lot of stuff. I wish I could grab a caliper and measure candy bars from the same company but in age differences of 10 and 20 years. Perhaps some well stocked bomb shelters from the 80’s will have some candy bar artifacts. I’m guessing that there is a noticeable decrease in size.
Anyhow, with the sheer size of the Fed money injections, if the velocity of money does increase, I am a mild hawk on inflation. Perhaps not this year and maybe not even next year but I don’t see how this can be unraveled smoothly. That’s why I still like residential real estate and some well bought commercial properties. Just imagine having a fixed rate of 5.16% o mortgage when inflation is 7%.&t;>