Risky assets performed well this week despite worse than anticipated economic data. Consumer prices came in right on top of expectations, 2% YoY (.9% Core YoY), but the disappointments came in housing starts, building permits and initial jobless claims earlier in the week. Comments from the Fed assuring that ZIRP will continue to live on drove stock prices higher but also kept rates lower in an interesting week for stock/bond price action.

So why don’t inflation expectations explode higher when Bernanke and Fed keep the pedal to the metal on monetary policy? I don’t fully know. The deflationary effects that Europe’s problems can potentially have on US exports are part of the answer, and credit remains tight due to uncertainty from companies unwilling to expand because of countless uncertainties. But the truth is, Fed Funds has been at zero since December 2008, and negative on a real basis since November 2009. The effects of such extremely accommodative monetary policy are not being felt right now because of how slow money is moving through the credit markets. The money multiplier remains at recorded lows, but history is bound to repeat itself here. Central banks have throughout history done a terrible job of removing stimulus before inflationary problems are already embedded. The risk is only compounded now with the independence of the Fed disappearing more and more every day.

I’m not calling for runaway double digit inflation, but the current TIPS market predicts inflation averaging 2% over the next ten years. In my opinion that’s wrong. With the Fed continuing to press forward with their benchmark rate at .25% in the face of 2% annual inflation over I think TIPS will outperform nominal Treasurys over a multiple year time horizon.

Have a good weekend.

Cliff J. Reynolds Jr., Investment Analyst