March 4, 2002; Bond Markets Pointing to More Inflation

Though the expected inflation rate remains low it seems to be trending up in the past few months (see Chart).  Since the turmoil surrounding the bankruptcy of Enron, the yield on

the benchmark ten-year note has been close to flat at about 5.0% (see top line).  The real yield on the ten-year Treasury Inflation Protected Security (TIPS) seems to be declining gradually from about 3.6% to about 3.3% (see middle line).  The yield spread between the two is a measure of the rate of inflation for the next ten years expected by bond investors.  A widening spread is reflected in rising implied inflation from about 1.4% to about 1.7% (see lower line).

Should the inflation trend continue to strengthen it implies more demand for energy investments.  Because we all need energy every day we will readily pay a price that keeps up with inflation.  We don't know if the trend is going to continue, but we believe a diversified investor should have protection against that possibility.  TIPS and energy stocks offer such protection.