No Sign of Inflation in Europe

" [U] ncertainty is very high," "more of a bumpy road ahead" -- Jean Claude-Trichet made these comments during a press conference this afternoon in Europe following the European Central Bank's rate decision. ECB officials left interest rates at 1%.

In an introductory statement, Trichet discussed the positive turn in economic data but then wrote, "However, uncertainty remains high and the persistent volatility in incoming data warrants a cautious interpretation of available information. Overall, the recovery is expected to be rather uneven, given the temporary nature of some of the supporting factors and the ongoing balance sheet correction in the financial and non-financial sectors of the economy, both inside and outside the euro area."

When asked whether unemployment could rise and the economy slide next year, Trichet said, "Uncertainty remains a major, major element." Referring to the risk of medium- to long-term inflation, he said the bank remains alert but that the time to fight inflation is not now, adding "when it is time, we will do it."

Unlike the U.S. Federal Reserve, the ECB has a single mandate to maintain monetary stability, but similar to Fed officials, the ECB sees a difficult path to recovery. While the Fed seemed to lean toward warning of shocks, Trichet repeatedly referred to the "bumpy road," essentially saying that it's possible that growth will swing from positive to negative ("less flattering evolution" in his words) from quarter to quarter.

Low inflation is positive for income funds and high-quality European debt is an option. Although there is not a Eurozone bond ETF in the U.S., investors with access to the London market may consider funds such as iShares € Government Bond 15-30 (IBGL), but these ETFs are extremely illiquid. The best bet for sophisticated investors who want direct euro exposure is to consider purchasing the bonds of euro governments, with Germany as the most financially prudent option.

For American ETF investors, there is SPDR Barclays Capital International Treasury Bond (BWX - commentary - Trade Now), which has 23% of assets in Japan and more than 4% in the United Kingdom and Canada. Some 40% of assets are in euro countries listed among the top 10 holdings, while part of the 27% of assets spread across "other" countries include Denmark, Sweden and Austria, in addition to small holdings in Mexico, Poland and Taiwan.

Investors betting on a weaker dollar can leave their holdings unhedged, but investors who want to capture yield and appreciation with less currency risk could add PowerShares DB U.S. Dollar Bullish Fund (UUP - commentary - Trade Now) to hedge a portion of their exposure.

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At the time of publication, Dion had no positions in the funds mentioned.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.