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Evidence doesn't support Greenspan's latest bubble talk

David Nicklaus/TNS Wire • Aug 21, 2017 at 3:00 PM

Even though inflation has been low for nearly a decade, certain worrywarts continue to look for it around every corner.

Among the current crop of inflation-phobes is Alan Greenspan, the former Federal Reserve chairman. He said recently that sometime soon, a resurgence of inflation will pop the bubble that’s been building in the bond market.

Greenspan wasn’t specific about how high inflation will go or when this will happen, but he did say the economy is moving toward “a stagflation not seen since the 1970s.”

That’s a scary thought. Stagflation — the word coined to describe the combination of stagnant growth and double-digit inflation — made investors, job seekers and just about everyone else miserable during that dismal decade.

Recent inflation readings don’t look anything like the horror story of the 1970s. In fact, the Federal Reserve has fretted for years about inflation being too low. It would like to see inflation of about 2 percent, but the latest reading on its preferred measure is just 1.5 percent.

The Consumer Price Index, the most widely reported inflation gauge, is up just 1.7 percent in the latest 12 months. It’s been under 2 percent for most of the last five years, except for a couple of brief surges driven by energy prices.

Fed officials have generally argued that the lull is temporary and that inflation will soon be back up to 2 percent, but some of them are beginning to doubt that story.

“Recent inflation data have surprised to the downside and call into question the idea that U.S. inflation is reliably returning toward target,” James Bullard, president of the St. Louis Federal Reserve Bank, said in a speech last week.

When a thoughtful policymaker such as Bullard is worried about inflation staying too low, do we really need to worry about a sudden upward leap?

Paul Christopher, head global market strategist at Wells Fargo Investment Institute, says several deflationary forces should continue to keep a lid on inflation. They include globalization, the growth of online shopping and price-comparison tools and a glut of oil and other commodities.

Christopher’s forecast is for a sort of Goldilocks outcome. “We see a steady but slow trend back toward 2 percent inflation,” he said. “We think that’s a benign environment.”

James Bohnaker, an economist at IHS Markit, is also in the Goldilocks camp. “Over the next 12 to 18 months, we may see the wage growth and CPI numbers start to accelerate a bit, but it’s going to be gradual,” he said.

As for the bond-bubble part of Greenspan’s prediction, that’s something he has been saying for a while, and bond-market bulls do seem to be living on borrowed time. Even as the Fed has pushed up short-term interest rates this year, the yield on the 10-year Treasury note has actually fallen from 2.4 percent in January to 2.2 percent now.

Bond investors say there’s good reason for that. “The world is awash in cash looking for income-producing assets of high quality,” says Dan Heckman, senior fixed income strategist for US Bank. “There aren’t enough of those assets to meet that demand.”

Heckman says bond yields should rise over the next year, but not rapidly enough to feel like a bubble popping.

If you’re alarmed by Greenspan’s comments, reflect for a moment on his record as a forecaster. He famously detected “irrational exuberance” in the stock market, but he made that comment in 1996, more than three years before the 1990s bull market ended.

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