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Fed’s Soft Target = 2% Inflation; Low Rates Til 2014 Means Bernanke Screws Savers?

Your Money: Keeping an investor’s eye on Fed plans that may trigger inflation

 

With the government pumping money into the economy and the Federal Reserve pledging to keep short-term interest rates low until late 2014, inflation could soar. What’s an investor to do?

Pure savers will lose. Low interest rates mean that your deposits aren’t going to earn much of anything for the next three years. You’re going to lose money on holding cash – after inflation.

JPMorgan’s Chris Millard explains that with a 2.0-2.5 percent inflation rate, “that means if you leave your money in cash for the next three years, you lose 2.5 percent of that every year. And that’s a tough idea for people to accept. They’re worth 2.5 percent less each year by doing nothing. Low rates are essentially a tax on savers.”

In previous columns, we have highlighted ways to seek out yield amid historically low U.S. interest rates: fixed income instruments like corporate bonds with yields above the inflation rate, as well as high-dividend yielding stocks.

There is also the option of investing in emerging markets, for instance through an exchange traded fund such as iShares MSCI All-Country Asia Ex-Japan Index Fund (symbol: AAXJ), considered a proxy for investing in China.

At this point, the risks of inflation are also important too for bond investors to consider, according to a recent paper by Fidelity’s Dirk Hofschire and George Fischer.

The economy could turn out to be in mild “stagflation” – a situation in which the economy and incomes muddle along at a slow rate, while inflation grows at a faster pace, but not as virulently as in the 1970s.

A stagflationary environment points investors toward inflation-resistant categories of bonds, such as leveraged loans, real estate bonds, or TIPS.

Avoiding the United States altogether, the Loomis Sayles Bond fund (LSBRX) invests in non-U.S. emerging market debt with above-average yields. The iShares Global Inflation-Linked Bond Fund (GTIP) aims to beat higher inflation around the world, not just in the U.S.

Precious metals are another potential haven if you think inflation will be higher than the Fed’s target rate.

But precious metals are not for the faint of heart; late last month, gold rose to $1,713 an ounce, up nearly $45, or 3 percent, in one day. Gold ounces have been risen from $1,347 to almost $1,900 over the last year. On Monday it closed at $1,722 an ounce.

Even PIMCO bond giant Bill Gross, in his latest letter, invoked gold amid the Fed’s zero-interest rate policy: “Zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly. It may as well induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper.”

Finally, there are specialized anti-inflation ETFs like Index IQ Real Return ETF (symbol: CPI), which seek to generate a real return above the rate of inflation as measured by changes in the Consumer Price Index. But CPI is a fund of funds, which according to IndexUniverse.com, makes it inherently more expensive than a traditional ETF. Be sure to check fees and expenses before investing in these types of niche products.

 


Erin E. Arvedlund is a finance reporter in Philadelphia. Contact her at erinarvedlund@yahoo.com or 646-797-0759. Read more of her columns at www.philly.com/arvedlund

Read more: http://www.philly.com/philly/business/personal_finance/20120207_Your_Money__Keeping_an_investor_s_eye_on_Fed_s_plans_that_may_trigger_inflation.html#ixzz1m0Pp4ox2

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2 responses

  1. Great article. This highlights the reasoning for a focus on “total” return. Not just income. There’s a great white paper from vanguard you should read on this topic. Want me to send?

    February 10, 2012 at 10:00 pm

    • absolutely! thanks for sending

      February 10, 2012 at 10:03 pm

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