The Federal Reserve yesterday left no doubt that it’s worried about inflation. Not worried enough to raise interest rates, but worried nonetheless.
Announcing that it would keep Fed funds at 5.25%, the FOMC advised that the “predominant policy concern remains the risk that inflation will fail to moderate as expected.” True, the central bank believes otherwise, predicting that inflation pressures appear “likely to moderate.” But it’s sleeping with one policy eye open just the same.
Or so we’re told. It’s debatable whether the back and forth is comforting or frightening. In any case, the Fed will have to act eventually, for good or ill. Meanwhile, they’re watching and so we can all sleep peacefully.
Well, almost everyone. The gold market, for one, is skeptical. An ounce changes hands for around $680, just under generational highs set a year ago. Commodities generally haven’t thrown in the towel on the inflation debate either. The CRB Index, although well off its highs in 2006, looks intent on keeping an open mind about the future path of pricing pressures.

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Strategic investors looking for explicit opportunities for rebalancing portfolios among the major asset classes are still faced with modest opportunities, at best, so far in 2007. As our table below documents, bull markets continue to prevail across the spectrum. That’s good news for tabulating past performance. It also gives diversification a good name. But the trend doesn’t necessarily impress when it comes to formulating a guess about expected returns.

Asset allocation is nothing if not a strategy for deploying capital that assumes humility about forecasting the future. Indeed, if investors knew what was coming, asset allocation would be about as relevant as carrying back-up ice cubes in Antarctica. But the future is, in fact, unknown, contrary to what you may have heard elsewhere. As such, owning a variety of assets, preferably those that move with a degree of independence from the others, is the only game in town for investors intent on the twin goals of growing capital while minimizing the associated risks.
That brings us to the current dilemma of finding alluring asset classes for fresh injections of capital, or redeploying money from assets that have run up to those that have fallen. On the one hand, there are obvious areas to pare, particularly for investors that long ago made commitments to some or all of the markets noted above. The problem comes in deciding how to redeploy. Alas, there are no asset classes that have fallen recently, at least not among the publicly traded ones with related index funds and ETFs.

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The labor market isn’t everything, but it’s a lot.
In fact, if you’re trying to get a handle on the big picture, you could do a lot worse than watch the economy’s capacity for minting new jobs.
With that in mind, the optimists have another stumbling block to conquer with today’s the release of April jobs data. Nonfarm payrolls increased by a slim 88,000 last month. For those who are still counting, that’s the smallest gain since November 2004.

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The Federal Reserve is scheduled to convene its FOMC meeting next Wednesday to decide on what happens next with the price of money. By most accounts, the assembly promises to be a yawn. Fed fund futures anticipate no change any time soon by predicting that current 5.25% will remain the standard for some time.
Perhaps that’s a prudent choice for policy makers, considering that full and clear clarity on the economy remain elusive. As we wrote yesterday, there’s a case to be made that the glass is half full as well as half empty. Indeed, economic data in recent months have dispensed conflicting signals.
Yes, that’s always true. But the stakes seem especially high at this juncture, with the economic cycle at middle age or later. Meanwhile, the capital markets have been running for some time. Value isn’t exactly gushing in abundance when it comes to such metrics as risk spreads and earnings ratios over price. Of course, if you think that the recent past will continue into the foreseeable future, there’s nothing much to do but hang on and collect the capital gains.
Enter the Fed, which theoretically must keep inflation at bay while juicing the economy and sidestepping a recession. A thankless task, and one that may be impossible. In short, the central bank must pick one or the other, or so one might assume.
If so, we present evidence that juicing the economy may be the preference these days. M2 money supply, the broadest measure published, has been pushing higher for some time now, as our chart below shows. Based on rolling 52-week percentage changes, M2 rose by nearly 7% for the year through April 9, although it’s since slowed to 6.3% That’s the fastest rate of printing money in more than three years.

The rise in the annual change in M2 has been fairly consistent this year, suggesting that the central bank is deliberately injecting money into the system in higher absolute and relative quantities. How fast is the recent 6%-plus rate of growth in money supply? More to the point: is it too fast? One might answer “yes,” based on the fact that first-quarter GDP advanced by 5.3% in nominal terms (or 1.3% in real terms), according to the Bureau of Economic Analysis.

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Once again, it’s too close to call.
The latest batch of economic data released so far this week suggests there’s reason for hope. Sort of. Maybe. Perhaps.
Let’s start with construction spending, which rose by 0.2% in March, the Census Bureau reported on Monday. That’s the second monthly rise in a row, reversing what had been a year of declines or virtually unchanged reports on construction spending. Unfortunately, on a rolling 12-month basis, the ship is still sinking. The 2% drop in construction spending in March compared to a year earlier is one of the sharpest declines in recent history, second only to January’s slightly bigger stumble.
Rather, the obvious good news on Monday was the fact that disposable personal income continued rising in March. In fact, March’s numbers show that income advanced by 0.7%, among the stronger paces in recent history, the Bureau of Economic Analysis advised. Alas, Joe Sixpack seemed reluctant to spend that windfall. Personal consumption expenditures rose by only 0.3% in March, a fairly middling reading of late, and down sharply from February’s 0.7% surge.

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The future’s unclear, but the past is the apex of clarity. Alas, the past is only a rough guide, at best, to what’s coming. But the past is all we have, along with predictions. Putting the two together may or may not help, but beggars can’t be choosy when it comes to investing.
With that in mind, your editor considered the past, as defined by equity market capital flows, volatility and correlations among the major asset classes in the April issue of Wealth Manager. There are some nuggets of perspective embedded in the data. Nothing earth shattering, perhaps, but at least we can’t be charged with ignoring history. Whether that leads to tangible benefits remains to be seen. Meanwhile, here’s what we found….