CIO Insights: Don’t Be Complacent About Inflation in 2013

The Global Macro Strategy Team at American Century Investments expects U.S. inflation to remain largely contained in 2013. But we do expect price pressures to build—fueled by low interest rates, extraordinary monetary stimulus, the housing recovery, and overseas growth—which, over time, could threaten to erode the purchasing power of savings and investments. We believe investors who haven’t done so yet should consider building long-term strategic positions in inflation-indexed products and/or other inflation hedges.

Potentially Bigger Threat in a Low-Return Environment

There’s been a lot of talk of a scaled-back “New Normal” in the wake of the 2008 Financial Crisis and Great Recession. Some of that talk has centered specifically on investments—how investors going forward shouldn’t expect the magnitude of returns they’ve received in the past because fundamental growth levels might be more modest.

In a landscape of possibly more-modest returns, the threat of inflation potentially looms larger, even at average levels. Recall that just 3% inflation over 10 years can turn $100,000 into $74,409 in today’s dollars. That’s a considerable hurdle to overcome.

Not an Immediate Threat

It’s easy to get complacent about inflation because it doesn’t appear to be an immediate threat. On December 14, the U.S. government’s Bureau of Labor Statistics reported that consumer prices declined 0.3% in November, and increased just 1.8% over the 12 months ended November 30.

Earlier that week (December 12), the U.S. Federal Reserve’s interest rate policy committee, the FOMC, stated: “Inflation has been running somewhat below the Committee’s longer-run objective,” and, “inflation over the medium term likely will run at or below its 2 percent objective.”

Extraordinary Measures with Potential Inflationary Implications

The FOMC clearly appears more concerned about possible recession than about inflation, and seems willing to risk future inflation to boost current economic growth. After four years of extraordinary measures to combat the Financial Crisis and the Great Recession, the FOMC is still providing enormous stimulus to the struggling U.S. economy, and is targeting unemployment.

In its December 12 policy statement, the FOMC announced an extension of recent bond-buying programs (under which it will now be buying an unprecedented combined total of $85 billion per month of U.S. government debt and mortgage-backed securities for an open-ended period) and the continuation of its historically low (0–0.25%) interest rate target for overnight bank loans (a key short-term interest rate benchmark).

Planning for What’s Unexpected and Potentially Harmful

Our Global Macro Strategy Team is less fixated with recession than the FOMC appears to be—our base scenario going into 2013 is for a subpar recovery with U.S. economic growth between 1% and 3%. We think there’s about a 22% probability of rising inflation (above 3%). Besides the FOMC’s extraordinary stimulus, some of our inflation concern comes from the housing recovery, overseas growth (causing constraints on resources), and a potentially weaker dollar (resulting in higher prices for imported goods).

You don’t just make plans for what’s most likely to happen—you also plan for what’s unexpected and potentially harmful. Inflation fits that bill. We believe it’s important for investors to check to see that their investment portfolios have at least some holdings designed to provide inflation protection. American Century Investments offers a full suite of such products, managed with the guidance of the Global Macro Strategy Team.

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Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.

The opinions expressed are those of G. David MacEwen and are no guarantee of the future performance of any American Century Investments portfolio.

For educational use only. This information is not intended to serve as investment advice.