Due to the financial crisis that began in 2008, interest rates are at extremely low levels. The Federal Reserve has currently set the fed funds rate at between 0 -.25% and this level is expected to be maintained for “an extended period.”
This low-level of interest rates, along with current and future levels of government expenditures, has led many investors to question or consider the impact this will have on future inflation rates.
A member of the Federal Reserve Board of Governors, Kevin Warsh, wrote an Opinion column that was published in the Wall Street Journal on September 25, 2009. He stated that long-term inflation expectations are stable and an economic conditions are likely to warrant exceptionally low level of interest rates for an extended period of time.
He then focused on the future. He stated that “we are at a critical transition period,” of an unknown duration and that “we must prepare diligently for an uneven road race ahead.” What he was beginning to address was how the Federal Reserve would increase interest rates in the future, to avoid inflation rates to rise to levels higher than desired.
In the past, when the Federal Reserve would increase interest rates, it has at times done this in .25% increments every few months. His comments indicate that once the Federal Reserve anticipates that it is the appropriate time for such an increase in interest rates, this may not be the pattern that they implement. He stated “that prudent risk management indicates that policy likely will need to begin normalization before it is obvious it is necessary, possibly with greater force than is customary…”
While the raising of interest rates may not occur for a while, we view these comments as positive. As the Federal Reserve had to act creatively during the inception of this crisis, the implication of these comments is that they will attempt to be proactive and take action to avoid much higher than normal levels of inflation in future years.
We cannot anticipate or predict future interest rates. In the structuring our fixed income portfolios, we purchase what is referred to as a laddered portfolio, which means that we will buy securities over a somewhat even period of time, rather than placing a significant bet as to how and when interest rates will change. Further, as appropriate to a specific client, we have been investing for a number of years in both TIPS (Treasury Inflation Protected Securities) and commodity mutual funds, both of which provide hedges against significant rises in inflation. We have been investing in both of these asset classes for a number of years and feel that they should be included in most investors portfolios.