Rob Arnott On Inflation

Investment News recently interviewed Rob Arnott and reported on his views of inflation potential.  Arnott sees inflation returning as soon as economic activity returns to a slow or moderate rate of growth.  He points out that monetary growth  associated with Quantitative Easing 1 and 2 has not been inflationary only because they (and the fiscal stimulus package passed in 2009) have been ineffective.  Specifically,

"Until the velocity of money accelerates, the vastly expanded money supply doesn't turn into inflation,” Mr. Arnott said. “So we've been protected by a sputtering economy. If the economy regains traction and we get slow to moderate growth, we'll see [higher] inflation sooner than we'd like, possibly later this year or into next year.”

 If inflation is too many dollars chasing too few goods, then the injection of liquidity into the economy is bound to be inflationary.  It will take a sustained, if modest, recovery to affect capacity sufficiently that output constraints would be felt.  This is how Arnott arrives at his inflation forecast.

The story reports that Arnott is relying on commodities and emerging market equities (which tend to be commodity related) to hedge inflation risk.  As TIPS yields are so low, this might be the best strategy for inflation protection.  Other options include REITs (look toward property types with short lease terms, like hotels and apartments) and variable rate debt (senior loans and adjustable rate mortgages).  Cash and very short-term bonds will also provide protection.