The inflation conundrum
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Long-term bond funds, like TLT below, are testing primary support as Treasury Yields edge upwards.
While TIPS funds, like LTPZ below, are decidedly stronger.
The divergence warns that inflation expectations are rising.
Introduction of an effective vaccine early in 2021 would accelerate the divergence.
The Fed flooded financial markets with liquidity in the second quarter, causing broad money growth (MZM plus time deposits) to spike upwards.
We were assured by many pundits that there was no need to worry about inflation as the velocity of money (GDP/money stock) was falling. But introduce an effective vaccine and all bets are off. GDP growth in that case is likely to recover a lot faster than the Fed can withdraw liquidity without upsetting financial markets as it did in 2010.
The Fed is then faced with a difficult choice: tolerate higher inflation or throw the US Treasury under the bus by withdrawing liquidity from financial markets — and support for new Treasury issuance. Our bet is on higher inflation.
Quote for the Week
The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.
~ Alan Greenspan
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Disclaimer
Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.
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