The Reflation Trade Is On

Includes: UDN, UUP
by: Hard Assets Investor

by Brad Zigler

Real-time Monetary Inflation (last 12 months): 0.1%

Notice anything different? Look up a bit to the subhead. See the monetary inflation number? It's positive. Barely so, but it's positive. The last time the one-year monetary inflation rate was positive was May 5 (click to enlarge).

One-Year Monetary Inflation

One-Year Monetary InflationClick to enlarge

This resurgence in inflation may seem disconcerting if you follow the trend in the Consumer Price Index. After all, the one-year inflation rate for CPI's been positive since November 2009.

CPI and the monetary inflation index, however, measure very different things. CPI reflects changes in the value of a basket of goods and services purchased domestically. Monetary inflation meters the U.S. dollar's global purchasing power in gold versus that of a competing reserve currency, the euro.

Put simply, a strengthening dollar is reflected in a declining inflation rate, a condition predominant from December 2009 to June 2010. Then, this summer, the dollar began to cheapen vs. bullion and the euro, which was reflected in a turnaround in the one-year inflation rate.

That brings us to today, the rate's first foray above the zero line in 102 trading days. Monetary inflation—that is, increases in its one-year rate—tend to precede hikes in domestic wholesale and consumer prices (click to enlarge).

One-Year Inflation Rates (Monthly Data Points Through August)

One-Year Inflation Rates (Monthly Data Points Through August)Click to enlarge

For example, bottoming in the monetary inflation rate in February 2009 foretold the July nadir in both the Consumer Price Index for Urban Workers (CPI-U) and the Producer Price Index For Finished Goods (PPI-FG). The subsequent peak in the monetary inflation rate, reached in November 2009, was a month ahead of the CPI's zenith.

Having a head start on inflation (and disinflation) is a competitive advantage for traders and investors alike. Especially when you consider the reporting lag for CPI and PPI data. The Bureau of Labor Statistics usually reports these two indexes a couple of weeks into the month following the reported month. That's why the chart above ends with August values. The government hasn't yet released September data.

That's not a problem faced by watchers of the monetary inflation index, though. This index is computed daily to give investors a real-time look at the trend in the dollar's purchasing power.

All you have to do is look at the subhead of each Desktop column to find the current one-year rate.

Now you know. Feel free to trade accordingly.