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Fed Has Time Before Inflation Hits

Sonya Morris, CFA

Sonya Morris: Speaking of that colossal governmental response, just basic Economics 101 tells you that's sort of no-brainer inflationary situation, yet we're hearing both sides. We're hearing that inflation is down the road, but there are other managers who are more worried about deflation. Where do you come down on that?

Mary Ellen Stanek: We think it's worthy to be concerned about it. Certainly paying a lot of attention, putting up a lot of screens to try to determine at what point the Fed begins to extract some of this liquidity.

And the way we think about it, the private sector went on strike a year ago last fall. Post-Lehman, completely pulled back. And so the federal government put its own balance sheet in to effectively save us from even more catastrophic downward pressure on asset values and pricing.

So the big question is, how much is too much? And it was a massive response, but they did not want to run the risk of another 1929, early '30s Great Depression kind of scenario. So erred on the side of a lot of liquidity.

We watch a couple of things. One is the labor markets. We see very high unemployment levels, probably going higher. We look at costs of labor, unit labor costs. And we continue to see downward pressure on the price of labor.

Typically inflation, to get inflation rising dramatically and become problematic, you have to see it typically start moving into the wage structure and benefits structure. We're seeing just the opposite.

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So we look worldwide and we see this output gap that's out there. We say to ourselves we think the Fed has time. We think they have some time because of this output gap, that not immediately is there a problem. And in fact there are those that say the problems are the other way, we ought to be concerned that we are seeing a very modest and moderate response from the private sector at this point.

We think there's time, but at some point, the Fed does have to start pulling back. One thing that was probably arguably one of their most impactful decisions was to take short rates down, the Fed Funds rate down, to effectively zero. It's happened only one other time in modern history that we can find.

And what that did was it forced investors off the sidelines. You could in a money market fund or stay in T-bills or stay in cash, but at some point you started seeing money moving out and investors start going back out into the bond market, and in the short and intermediate bond products, and continue to move out.

So all of that has been very, very healthy. And we think in the long run one of the things the Fed needs to start doing is paying attention and start moving that up and start extracting some of that liquidity.

So what do investors do? In our opinion, stay high quality and stay short and intermediate in duration. Now is not the time to be going down in terms of quality and reaching for yield and reaching for risk. And now is the not the time to take a lot of time risk either.

If you look at what's available in the bond market, particularly that short and intermediate space is very attractive. You get a great deal of the yield that's available out there without taking undue risk. We think that's a way for most investors to participate.

We, for most individuals, believe the best way to do this is in funds. You get the diversification, you get the liquidity, and the professional management. And while that might be a self-serving comment as a fund manager, it's certainly how we invest in the markets ourselves. Or as I like say, my mom invests in the funds.

And with all kidding aside, that is the way to get to participate yet get the liquidity and the diversification that have been in rosier time periods taken for granted, but certainly over this last year are very, very important.

Morris: Great. Mary Ellen Stanek, thank you for joining us today.

Stanek: Thanks, Sonya.