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Investors hear a lot of talk today about how the massive spending by the Federal as well as State Governments along with the potential for a pick-up in economic activity during the latter part of 2009 and into 2010 may be inflationary. To this point we can agree. However, until all of the excesses in the economy get soaked up, inflation remains at bay.
This past week at the conclusion of their regularly scheduled meeting to determine, amongst other items, the direction of interest rates, the Federal Reserve’s Open Market Committee issued a statement outlining their reasoning behind keeping interest rates at 0.25%. They stated that “information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out.”
Furthermore, they noted that despite the fact that “household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.”
Contained within this statement is also the conclusion that despite the fact that “prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”
Their conclusion is our conclusion. Digging a bit deeper than the policy statement, one can find that Capacity Utilization, the percent at which our nation’s mine, factories, and utilities operate at remains near historic lows. This excess capacity must be soaked up before any inflationary pressures mount.
The Unemployment Rate stands at 9.4%, a multi-decade high. Furthermore, assuming that all of those that needed jobs were actually looking for them, the Unemployment Rate would approach 16%. Once again, before any inflation pressures mount regarding wages, the rate of unemployment would have to fall substantially.
Factory hours worked ticked up last month to 33.1 from 33.0 hours. However, this figure represents an historic low. It would be natural for employers to offer more hours to their current employees rather than hire new ones. Once again, this should keep the unemployment rate relatively high and wage growth tame.
Finally, consumers continue to repair their balance sheets by deleveraging. The Federal Reserve recently reported that consumer credit dropped by $10.3 billion this past month, an unprecedented fifth consecutive monthly decline. We believe that this deleveraging is part of a secular trend that will continue into the foreseeable future thereby reducing the pricing power of retailers and therefore controlling inflation.
THE BOTTOM LINE – Don’t expect inflation and therefore interest rates to tick up anytime soon. We would strongly recommend that your investment portfolio reflect this expectation by looking for alternatives to Certificates of Deposit and other Fixed Interest Accounts. Otherwise, the level of investment income will be far below what you are accustomed to and perhaps what can maintain your standard of living.