Overview: The purpose of this commentary is to illustrate that the credit markets continue to heal, providing further evidence that the Fed’s policy actions are having their intended effect.

 

The credit markets continue to exhibit healing as conditions, while not yet fully restored to pre-crisis levels, are normalizing. For example:

On another note, we think it important to note that fears of inflation due to a rapid increase in the money supply are overstated. It is true the Fed’s actions have led to a more than doubling of the monetary base since last fall. However, the money supply had been growing at only around 10 percent, and even that rate of growth has slowed recently. If the Fed had not acted to increase reserves, the money supply would have fallen sharply and the economic crisis would almost certainly have deepened.

 

We do not mean to minimize the risks of inflation. As the economy recovers and people begin spending again, the Fed must remove the reserves it had injected or else the money supply will soar and inflation will follow. The risk of this occurring is one reason we continue to recommend that investors consider including a significant allocation to TIPS in their portfolio and should generally avoid longer-term nominal bonds.