Bill Tedford is a market-beating bond manager at Stephens Inc. A recent Wall Street Journal article profiled his market outlook for higher inflation. Although I was not familiar with Mr. Tedford, the article had an interesting comment on his thoughts about the linkage between the monetary base and subsequent inflation.
The key data point in Mr. Tedford’s model: the monetary base, basically money circulating through the public or reserves banks on deposit with the Federal Reserve. Over long sweeps of time, he says, inflation closely tracks increases in the monetary base that exceed economic growth.
For instance, he notes, in the 40 years to 2007 the U.S. monetary base grew at 7.08% a year. Gross domestic product, meanwhile, grew at 3.04%. The resulting surplus monetary-base growth of 4.04% closely matches CPI and the personal-consumption-expenditures price index, another measure of overall inflation.
I always love models that are based on actual data, so that’s a pretty interesting relationship. Of course, recently the monetary base has exploded. According to the article, the monetary base has grown 11% in the past 15 months, during which GDP has actually declined 2%. The article also notes some caveats to his thesis, but it’s intriguing nonetheless.
One troubling aspect of recent media coverage is this: quite a few notable bond managers including Bill Gross, Dan Fuss, and now Mr. Tedford expect bond yields to go higher (and thus prices to decline) at the same time that the public is piling into bond funds. It’s too early to tell how things will really work out, but it certainly something to keep a close watch on.
