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SHORT U.S.
BONDS [10-year and 30-year] (Timeframe for idea: immediate as well as
longer-term trend):
While there
appears to be consensus among Fed governors that inflation will moderate in
the second half due to slower economic growth, the history of inflationary
periods suggests that inflation ends only when interest rates rise.
Worldwide,
interest rates remain at highly stimulative levels relative to price
appreciation, especially when data is normalized by taking out hedonics and
substitution, and when considering a prolonged period of disinflation brought
on by the globalization of labor may be coming to an end. In addition,
government spending, especially in the U.S., is further stimulative and
becoming more so. Clearly in the U.S., overconsumption is a problem, which
the market is trying to correct, but the Fed and government are trying to
ameliorate via stimulative measures. As recent market action has shown, such
stimulative measures are as likely to create more inflationary pressures as
they are to alleviate banking and housing problems. Inflation expectations
are becoming more entrenched and early evidence hints at inflation's
extension beyond commodities.
Should the
Fed's (and to some extent the market's) consensus opinion of moderating
inflation prove incorrect, the "flight to safety" into U.S. bonds
could turn into a "flight of panic" out of U.S. bonds.
As a final
point, the "reduced demand" argument for moderating inflation is an
oversimplified model of stagflation. Price increases CAN occur when demand is
falling if supply is falling faster. What is not obvious about stagflation is
that malinvestment can cause suppliers to pull productive capability faster
than demand is being destroyed. A recent example would be the airline
industry, where rising fuel costs and moderate demand are forcing many
airlines into bankruptcies and others to pull less efficient aircraft from
service, all of which allows for fare increases during a period of slowness.
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