Is The Number Up For The Fed’s Inflation Measure?

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Written By Hasan Rezazadeh

Lower for longer is the central bank mantra for interest rates – except for the US Federal Reserve.

Major banks such as the European Central Bank, the Bank of England and Bank of Japan have all joined the record low or negative interest rate club and look to remain members for the foreseeable future.

Financial expats even believe the Fed wants to join the club because although talking up prospects of a rate hike, the actual deed never seems to happen.

Chair Janet Yellon may surprise everyone at the forthcoming Jackson Hole summit.

The question for investors is how to profit from low, low interest rates.

To work this out needs some money market research.

Profits from low rates

Take government bonds. The Bank of England has had problems prising these away from institutional investors because the coupon is higher than the yield of current bonds and they are strategically thinking in terms of decades rather than a quick speculative hit.

Even though the rates are historically low, they are probably the best available and those issued this year and next are likely to yield higher than those coming further down the line.

The US financial market is also going to be out of step with the rest of the world at a time when rates are rising in America and stuck at record lows elsewhere.

One reason is the measure of inflation applied by the Fed.

Different measures

Although the US has a consumer price index (CPI), the Fed prefers the personal consumption expenditure index (PCE). The latter is based on a wider range of goods and services than the CPI and is 0.7% lower than CPI as well.

While the Fed makes decisions based on PCE, the markets price according to CPI.

The belief is the Fed is making economic decisions based on one, lower index while the markets are acting on a different set of figures that pulls prices and yields in a different direction.

That gives an opportunity for investors to slip in to benefit from the anomaly, which the Fed and other central banks are probably unlikely to let last for long.

“This is a rare combination of events,” said Chris Mahon, an investment director at Barings.

“We are allocating flagship funds to buying US inflation linked bonds.”