ABA Banking Journal - May 2013 - (Page 8)

the economy Scott Brown Why inflation is still low The Federal Reserve began its first asset purchase Negative TIPS yields program in the fall of 2008, during the depths of the 1.8 financial panic. Some observers feared that the Fed’s actions would fuel higher inflation. However, the 1.5 Fed is now well along in its third asset purchase pro1.2 gram, and inflation (as measured by the PCE Price 0.9 Index) has remained low. Fed officials expect that inflation will trend at or below the 2% target for the 0.6 next couple years. That hasn’t stopped worrywarts 0.3 from predicting it is still “just around the corner.” Inflation is a monetary phenomenon, but we 0.0 observe it building through pressure in resource -0.3 markets. The soft global economy has put downward -0.6 pressure on commodity prices. The large degree of slack in manufacturing means that we’re unlikely -0.9 to see bottleneck pressures pushing inflation higher -1.2 anytime soon. Most important, high unemployment -1.5 should continue to keep labor costs in check. The inflation process depends on inflation expec-1.8 Jan-10 Jan-11 tations. Higher expectations tend to become selffulfilling. But, the market continues to show that expectations remain contained. The spread between inflation-adjusted (TIPS) and fixed-rate Treasury securities isn’t an exact measure of expectations (there is a liquidity premium in the price of fixed-rate Treasuries and an inflation-uncertainty premium in the price of TIPS), but it does provide a reasonable first approximation. Well-anchored expectations reflect confidence in the Fed’s commitment to keep inflation low over the long term. Isn’t gold an indicator of inflation fears? Not really. It’s not an inflation hedge. Gold is sensitive to hype. In recent years, the drumbeat on gold has been hard to ignore. But, few people seem to remember what happened in the 1970s. Gold rose sharply and fell just as sharply. The main reason to buy, say gold bugs: Inflation is sure to take off. Yet, it’s remarkably low and expected to remain low. Fixed-income investors have been locking in negative real returns in Treasuries for some time. Do they expect inflation to rise? No. Negative TIPS yields reflect very strong demand for safe assets. Such demand should not have been unexpected following the financial crisis. Demand for safe assets has kept longterm interest rates low amid the increase in government borrowing of the last few years. As the economy recovers, government borrowing costs will rise. But in the near term, the federal budget deficit is set to decline further. What about the Fed’s exit from accommodation? Can it unwind at a pace sufficient to prevent inflation from taking off? It’s confident it can drain reserves 8| ABA BANKING JOURNAL | May 2013 reflect demand for safe assets 10 year 7 year 5 year Jan-12 Jan-13 Source: Federal Reserve from the system when appropriate. It can execute reverse repos and offer time deposits to depository institutions. It can raise the interest rate it pays on excess bank reserves held at the Fed. It can let its assets mature naturally over time. The unlikely worst-case scenario is outright sales from its portfolio. The low inflation outlook should allow the Fed to remain accommodative until the labor market shows substantially better improvement. n Scott J. Brown is senior vicepresident and chief economist, Raymond James & Associates, Inc., and a member of the ABA Economic Advisory Committee.

Table of Contents for the Digital Edition of ABA Banking Journal - May 2013

ABA Banking Journal - May 2013
Contents
Chairman’s View
Editor’s Column
The Economy
Bank Notes
Picture This
ABA Community Banking
Pass the Aspirin
Tech Topics
Looking for leaders
Top-performing mid-size banks
New world of appraisals
Compliance Clinic
Compliance Inbox
ABA At Your Service
First Person

ABA Banking Journal - May 2013

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