The End of the Goldilocks Age

June 27, 2011
PIMCO: The Goldilocks Age Of Strong Growth And Weak Inflation Is Over

Long-term, I absolutely believe that the Goldilocks combination of strong growth and weak inflation is over. We'll either have less growth, higher inflation, or both. I do not have a good handle on the weighting between growth and inflation though. That's why I have owned inflation protected treasuries and I continue to own them.

From Mihir Worah:

But let me touch upon one other asset class that we feel is very important: inflation-linked bonds. In the U.S., for example, they have the same credit risk as regular U.S. Treasuries, but the interest payments and principal are linked to the rate of inflation. To be sure, there is currently a valuation issue with inflation-linked bonds as real rates on such bonds are low. But we believe those rates are likely to stay low – one way for developed markets to escape from their debt overhang is by artificially keeping real rates low, either through regulation or through higher inflation via inflationary/low-rate policies. So in our view, inflation-linked bonds have the potential to hold their value while serving as a cornerstone of an inflation-hedging strategy.

I too believe that real rates will remain low. I've been predicting the death of real yields since starting this blog (and long before it). TIPS are therefore not just my cornerstone. They are nearly my entire stone.

I have been investing in TIPS and I-Bonds since 2000. I don't think it will work out as well in the future as it has in the past, but I do think it will continue to protect me. If nothing else, if I hold TIPS until maturity at least I won't require a greater fool at any point in the process.

By owning TIPS and I-Bonds, I bet that one of the following five conditions would be met and I continue to bet that way.

1. Moderate growth with high inflation.
2. Low growth with moderate inflation.
3. Zero growth with low inflation.
4. Low negative growth with zero inflation.
5. Moderate negative growth with actual deflation.

In other words, I don't see TIPS as an inflation bet. I can't predict inflation with any accuracy. It depends on too many factors that are outside of my control. Right or wrong, I did think I could predict inflation rising compared to growth though (either because inflation rises, growth falls, or both).

As a side note, I think the Fed is attempting #2 from my list. For the most part, we've averaged #2 over the past decade. We've had low growth with moderate inflation (with episodes of #1 through #5 from the list). That's about the best they can do though. Although some may feel the Fed plays the role of a deity, they can no more create prosperity out of thin air than they can transform dollars (water) into oil (wine).

This is not investment advice.

See Also:
Real Yield Infection (Musical Tributes)