NEW YORK (Reuters) - Talk of deflation isn't thick among investors but deflationary pressures pose a big worry and major hurdle for the Federal Reserve and other central bankers, guests at the Reuters Investment Outlook 2010 Summit said this week.
Fear of the abyss that gripped financial markets a year ago has dissipated and many investors see improving economic data from around the world as reason to believe the economic rebound that is now under way will only blossom further.
Yet some investors caution that high U.S. unemployment and a lack of credit to drive investment and spending are major impediments to a full recovery.
Chances that growth will remain anemic are strong. As a result, the Fed is likely to keep interest rates -- now close to zero -- pat through much of next year, spurred by the fear of deflation, these investors say.
"We are at risk of getting into a deflationary environment for the first time since the 1930s, a serious risk. I'm very concerned about that risk," said Aaron Gurwitz, in charge of investment strategy at Barclays Wealth, which has $221 billion in assets under management.
"Central bankers are very concerned about that risk, and for that reason we expect rates could be kept low for a very long time," Gurwitz told the Summit. "We expect some central bank action in the fourth quarter of next year, but just a token move."
Fed Chairman Ben Bernanke is faced with the difficult task of deciding when to scale back the enormous monetary stimulus the Fed has injected to revive the crippled U.S. economy. A move too soon could squash the economy and cause further pain, such as occurred in Japan a decade ago.
Gurwitz said the Bank of Japan tightened too quickly in 2000, choking off growth and pushing the economy back into deflation, which is when prices decline and further hobble growth. The Fed will err on keeping liquidity available, he said.
Pressure on wages and the inability of companies to increase prices are signs of deflation that suggest growth rates and inflation will remain low, said Bob Doll, who oversees about $390 billion in assets as global chief investment officer of equities at BlackRock Inc (BLK.N).
"How many industries do you know that are raising prices? How many industries do you know where there's a constant sale going on? These are all reminders that deflation is with us, and deflation means low nominal growth," Doll said.
The human spirit is to overcome diversity and move forward, but the number of hurdles the United States and other countries face makes chances of stumbling much higher than normal, said Max Darnell, chief investment officer at First Quadrant LP, where he oversees just under $18 billion.
The U.S. economy may be headed for a "double-dip" recession if broad access to credit remains impaired, he said.
"It's very hard to formulate well thought-out expectations for growth," Darnell said. "This is one of the reasons why you find so many people that are very objectively oriented, being more pessimistic."
Darnell cited the lack of credit as a major impediment to a return to solid growth.
Bill Gross, who runs influential bond management firm Pacific Investment Management Co, told the Summit Pimco expects the United States and other parts of the developed world to experience subpar growth.
While Gross said Pimco does not expect a return to zero or negative growth, and it expects positive, albeit limited job creation for the next three to six months, there is evidence of continued deflationary pressures.
Gross cited the property scare in Dubai last month and a downgrade in the credit worthiness of Greece as examples that, if not handled properly, could be downward tipping points.
Jonathan Xiong, a senior portfolio manager at Mellon Capital Management where he helps manage $18 billion in assets, said the United States must avoid replicating Japan's woes.
Since a property bubble burst in Japan 20 years ago the country has struggled to overcome deflationary bouts despite rounds of government stimulus spending.
"One very bad scenario is that we could end like Japan," Xiong said, adding that too many investors foresee the return of higher inflation, which is mistaken.
"The skew and the size of returns between a deflation and an inflation environment is enormous. The downside in a deflation environment could be horrendous," he said.
"You should let a little bit of inflation pick up before you take the liquidity away from the market because the deflationary story as we see it in Japan could be very detrimental," Xiong said.
(Additional reporting by Manuela Badawy; Editing by Andrew Hay and Leslie Adler)