Look for the inflationary dragons in the 'out' years

With no end to quantitative easing anticipated as the US tries to dig itself out of its economic hole, expect inflation and look for it where long-term bonds are measured, says PIMCO's Bill Gross.

Inflation will occur, writes America's top bond manager in his recent Investment Outlook, since Ben Bernanke is printing free money.

"When the Fed now writes $85 billion of checks to buy Treasuries and mortgages every month, they really have nothing in the 'bank' to back them," writes Gross.

"Supposedly they own a few billion dollars of 'gold certificates' that represent a fairy-tale claim on Ft. Knox’s secret stash, but there’s essentially nothing there but trust."

Inflation has not shown up in the economic statistics, rather there has been a long period of very low interest rates.

But Gross says investors need to know where to look. It's unlikely inflation will be felt this year, but it can be seen in the long-term movement of bonds.

Investors should be alert to the longterm inflationary thrust of such check writing. While they are not likely to breathe fire in 2013, the inflationary dragons lurk in the “out” years towards which long-term bond yields are measured. You should avoid them and confine your maturities and bond durations to short/intermediate targets supported by Fed policies. In addition, be aware of PIMCO’s continued concerns about the increasing ineffectiveness of quantitative easing with regards to the real economy. Zero-bound interest rates, QE maneuvering, and “essentially costless” check writing destroy financial business models and stunt investment decisions which offer increasingly lower ROIs and ROEs. Purchases of “paper” shares as opposed to investments in tangible productive investment assets become the likely preferred corporate choice. Those purchases may be initially supportive of stock prices but ultimately constraining of true wealth creation and real economic growth.

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Image by GerryT