Prices of imported goods have been steadily rising, making imported goods and raw materials more expensive for U.S. consumers. So the story has been told. But last Friday marked the fourth consecutive monthly decline in the Import Price Inflation Index, and the 12-month percentage change has been dropping steadily since last July.
Should investors, then, question the need to build inflation hedges into their portfolios? I believe the answer is no. In fact, there are global factors developing right now that may only make the need for building inflation hedges through international bonds and foreign currencies more pronounced.
The pullback in import price inflation may be due to a combination of factors, such as a 7.3% drop in commodity prices, an 11.8% appreciation in the U.S. dollar and downward pressure due to global growth slowdown over the past twelve months. However, to my mind, all of these things are shorter term events. Commodity prices are likely to be supported by growing demand in emerging markets, and we expect the value of the dollar to lose ground to the currencies of stronger growth countries in the developing world. And underneath the surface, there are fundamental changes taking place in the global markets that are likely to usher in a trend of rising import prices. I believe these will only augment the need for building inflation hedges.
Take this startling statistic: According to the U.S. Bureau of Economic Analysis, 88% of manufactured goods consumed in 2010 were imported. One of our largest trading partners contributing to that 88%, China, has been undergoing some dramatic changes over recent years that I believe could cause price increases of imported products, not least its rising labor costs that are outstripping productivity and the long-term appreciation of its currency versus the U.S. dollar, now a cumulative 30.1% since the end of the pegged exchange rate in July 2005.
It’s likely that these two trends may continue in the long term, which will eventually cause Chinese exporters to raise prices in order to preserve profit margins, which would directly influence import inflation in the U.S. Additionally, China’s huge market and large global import penetration could also cause import inflation to rise indirectly through spillover effects to other countries’ imports, as well as in domestic markets.
The short answer is that even if the Import Price Inflation Index isn’t rising right now, that doesn’t necessarily mean that investors should forgo building inflation hedges into their portfolios. On the contrary, now may be the perfect time to consider fixed income and foreign currency exposure to the U.S.’s largest trading partners in an attempt to help ease the pain of future rising import prices.
 Based on the S&P Goldman Sachs Commodity Index for the 12-month period ending 7/30/12.
 Based on the U.S. Dollar Index, a measure of the dollar’s value against the currencies of its major trading partners, for the 12-month period ending 7/30/12.
Fixed income investing entails credit risks and interest rate risks. When interest rates rise, bond prices generally fall, and the Fund’s share prices can fall.
Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes and political and economic uncertainties.
Currency derivative investments may be particularly volatile and involve significant risks.