|
Puzzling signs for economic outlook
By Ron Pearrow
Contributor
Published October 31, 2009
Are you confused about the economic outlook? Join the club. Any investment must include a forecast of the future and, by looking at various markets, you can determine what the investors are expecting.
Two of the most widely traded financial markets are anticipating conditions directly opposite to each other.
The falling dollar and rallying gold markets anticipate a pickup in the rate of inflation. The last time gold was near $1,000 per ounce, inflation was running at 10 percent or more.
The dollar and gold markets are concerned about the bloated deficits and how the government intends to finance them. The Federal Reserve has been financing part of the deficit by printing dollars and has investors worried this will lead to higher inflation. As a result, gold is rallying and the dollar is falling.
Given the expanding deficit and Federal Reserve actions, a pickup in the rate of inflation seems reasonable, but the interest rate on 30-year U.S. Treasury bonds is about 4 percent. In the past, when the inflation rate was 10 percent, the interest rate on 30-year bonds was above 12 percent.
Typically, the interest rate on bonds is the rate of expected inflation plus a premium to provide a return above inflation. Investors willing to lock up their money for 30 years at 4 percent do not expect inflation to pick up. Bond market investors are expecting prolonged economic weakness to keep inflation in check.
The currency and Treasury bonds markets are dominated by large institutions, banks and money managers. There is relatively little participation in them by individual investors. The fact that two sophisticated markets are forecasting such profoundly different views on the future of inflation is puzzling.
The forecasts implied by either the currency or bond markets are not particularly good. Inflation erodes the value of our savings and is particularly hard on those with fixed incomes. In addition, interest rates will rise, pushing up the cost of borrowing. The bond-market forecast suggests an extended period of slow economic growth. Slow growth results in higher unemployment, increased government spending on the safety net, small-business failures and lost opportunity.
Inflation or slower growth — which is likely to happen? Nobody knows, but watching the bond and currency markets can at least tell us what the investment professionals are thinking. A stronger dollar and stable interest rates indicate slower economic growth, while a weak dollar and rising rates tilts expectations toward increasing inflation.
Galveston resident Ron Pearrow is an occasional contributor to The Daily News about economic issues.
Share |
Save |
Mail |
Print |
Letter |
2
Comments
|
|
|
