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Follow the Fed with interest

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Inflation eventually becomes a concern as the economy expands, Bob Landaas says in a Money Talk Video. Meantime, Bob says, investors should remember that bonds typically are for safety. Here is a transcript of the video:

Typically during the expansion phase of the business cycle, money managers worry about inflation. It’s important to recognize that the Fed has created all but two downturns since the end of the Second World War by raising rates to try to reduce inflation. They solve the inflation problem but typically put us into recession.

So during the expansion phase of the business cycle, it’s really important to monitor the Fed’s activities, to look at the Federal Open Market policy committee meetings every seven weeks, and get a sense of where they’re going with interest rates. Right now, inflation is barely measurable. If you look at any of the major yardsticks for inflation – my favorite is the Personal Consumption Expenditures index, other people look at the core rate of the CPI – it’s been bouncing in the one-percent range now for a number of years. And typically inflation has to be above 2 percent for the Fed to get excited.

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At some point in time, I think inflation will take hold, but we’re a number of years away from that now. So the fact that interest rates are the lowest they’ve been in almost 32 years doesn’t necessarily imply to me that they’re about to take off anytime soon.

There are a number of things that concern me. One is the amount of money pouring into lower-quality junk bond funds. That’ll end badly. Remember, bonds are typically your safe money.

Junk bonds lost a quarter to a third of their value in the financial crisis. And it doesn’t make sense to me for investors to try to eke out another percent or two in their bond investments by lowering the credit quality when five years ago, that ended badly for your safe money.

The other thing that investors are doing that I think will end badly is extending the durations of their bonds to eke out another percent or two. And we all have to remember the formula: Multiply the change in interest rates times the duration of your bonds, and that’ll explain price movement. So if you’re out there only four years, rates go up a half, not hardly a problem. You’re out there at 30 years on your bonds, rates go up a half a percent, you’ll literally lose 15 percent of your bond portfolio.

Bob Landaas is president of Landaas & Company.

Money Talk Video by Peter May

(initially posted May 30, 2013)

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