Well, now that the title has hopefully gotten your attention I’d like to talk about the ‘d’ and ‘i’ words that so many financial types – myself included – throw around so often. This is due to a reader/subscriber KR’s aggravation at my use of the word deflation, which he had thought was meant sarcastically, but then came to find out I am serious when I use it.
First I want to note that I seem to have been pissing everyone off lately, gold bugs (one of which I am) and gold bears in particular. That is due to my writing style being one where if I’ve got something to say, I say it. Sometimes that’s bad for business, as I can get a little heavy handed.
I’ll try to be less heavy handed going forward but in criticizing what I view as promotion with little backing substance (whether bullish or bearish), I don’t retract any comments aimed at the type of people that I think are not being square with readers or are simply not doing the work required (i.e. promoting lazy analytical thinking).
No matter the debates over inflation vs. deflation, increasing employment vs. sound monetary policy or systemic health vs. fragility (and whatever else is flying around in Jackson Hole this week), the CPI marches onward and upward. That is the system and it is predicated on creating enough money out of thin air while inflation signals are (somehow) held at bay.
The Straw Man* in this argument lives in the idea that inflation is not always destructive, that inflation can be used for good and honed, massaged and targeted just right to achieve positive ends to defeat the curse of deflation that is surely just around the next corner. Currently, the Straw Man is supported by the reality of the moment, which includes long-term Treasury yields remaining in their long-term secular down trend.
It’s a busy I chart, I grant you. But these are my favorite charts because in their busy way they try to tell stories. The story told by TIP (Inflation protected Treasury bonds) vs. TLT (regular long-term T bonds) is not one of inflationary concerns. Quite the contrary, TIP-TLT shows a break down in inflation expectations.
The gold ‘community’ does not publicize this because it is antithetical to the fundamental they most often tout for gold (inflation). In the short-term, a deflationary bout may indeed be a negative. But in the longer-term, a failing ‘inflation trade’ would be what eventually builds stronger fundamentals for the sector. Again, economic contraction (with gold rising not necessarily in nominal terms but in relation to most everything else) is what the sector needs. Moderate the inflation hysterics.
The above picture would be positive for US stocks if it results in a continued Goldilocks atmosphere, but last year Goldilocks held sway with TIP-TLT gently rising but muted. It is debatable how well she would do if this indicator of deflationary pressure keeps dropping.
The economy and the stock market depend on inflation. Get serious giddy stock bulls, they inflate, you make money. They fail to inflate and the tide turns deflationary, your gains go poof, money heaven. I’ll dig out some of those policy-profits-S&P 500 corollary charts again soon enough.
The relationship between TIPS (inflation protected) and TLT (regular long-term T bonds) is one indicator of inflation expectations and while it seems to have spent the last 2.5 years in bottoming mode (allowing Goldilocks to pig out on porridge) it is still going nowhere.
What more needs to be said? The stock market has been inflated along with the unsavory likes of Junk Bonds and many other ridiculously over valued items in this phase of ‘risk ON’ speculation. 3 Amigos of ‘risk OFF’ are also shown on the chart.
This chart was put up a while back as the USB stabbed down below the supportive weekly EMA 350. With copper, oil and other commodities plunging one wonders about the ‘D’ word. At least this one wonders about it.
The long bond is at a critical point right now. Given some improving technicals on the US dollar and negative ones in commodities (and their currencies; seen the Aussie and the Canada dollar lately?), what the bond does at this juncture will be telling.
Everybody’s ready for the ‘Great Rotation’ out of bonds and into stocks, especially with anticipated Fed QE tapering being Thing 1 to start the year. The title asks whether deflation or inflation lay ahead. Of course we could have more of the same, with Goldilocks eating her just right porridge for another year, but I don’t think that is the most likely scenario.
Of course, deflation has been rendered little more than the lever needed by chronic inflators as they rationalize the endless bailout through monetary tricks. So disinflation remains a macro economic manipulator’s best friend.
For the entire history of the Federal Reserve prior to October of 2008, the Fed was not legally able to pay interest on bank reserves. However, the Emergency Economic Stabilization Act of 2008 gave the Fed the power to pay interest on reserves and the Fed has since made use of this power. We are going to explain why this change was made and why it greatly reduces the probability of future US deflation.
Here is the chart we have been using in NFTRH, showing inflation protected T bond fund TIP vs. regular T bond fund TLT.
This ratio has been bottoming for months now and in the last few weeks had made some failed efforts to break out. Last week it closed above the bottom pattern neckline.
From NFTRH 252:
“TIP-TLT can be thought of as a barometer to ‘inflation expectations’. That could be what the precious metals, led by silver, are indicating in tandem with the above ratio. At the very least, it looks like a ‘deflationary expectations’ phase – which helped feed Goldilocks and croak precious metals – may be ending.”
Goldilocks lived by the deflationary pressures that Europe’s meltdown and China’s slow down exerted upon the world. Now, with the latest TICS report showing China and Japan selling T bonds we suddenly have the Fed’s Huey, Dooey and Louie jawboning a ‘taper’ of bond buying in the media. Ha ha ha… as if they have a decision to make.
The Treasury TIC data are only through June, which just happens to be the month we observed the breakout from bottoming patterns in 10 year and 30 year bond yields. But the play always (and I am talking nearly a decade since we began following this dynamic) been that America’s voracious consumption habits would be used to build out the Chinese economy on credit. They would not let us abuse our ability to inflate without consequence forever.
Do they perhaps feel built out enough for the time being? We’ll find out in future TICS reports. But I’ll just say that everybody thinks they know that there is no inflation and in this market what everybody thinks they know could well stand to be wrong. I have rarely seen so many of the right people on the wrong sides.