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While the world has focused on fuel rods in Japan and fighter jets in Libya, issues that are ultimately much more significant for investors have gone largely ignored. For example, the Producer Price Index for February registered a 5.6% Year-Over-Year increase. That was the figure in the headlines, at least. The reality is much worse.

The month-over-month PPI increase was a staggering 1.6%, which translates to a 19.2% annualized run-rate. Economists will caution that the PPI is volatile and should not be viewed a month at a time. So let’s look at the longer term PPI trend.

This paints an even worse picture. The run-rate is not just high, it’s accelerating.

I can accept that the PPI exaggerates price swings; these swings don’t all get passed along to consumers. So let’s look at Consumer Prices. Last week, the media announced a relatively modest 2.1% YOY increase in Consumer Price Inflation (CPI-U). But this glosses over the fact that the month-over-month run-rate was a hefty 0.5%--or 6% as an annualized run-rate. The month-over-month trend for the CPI not as clear as for the PPI, but it is still execrable.

What About "Core Inflation?"

Supporters of current Fed policy will naturally point out that "core Inflation" was only up 0.2%. But even that run-rate gets us to 2.4% annualized. Moreover, some economists have derided the notion of "core Inflation" as "inflation minus price increases." They have a point. Inflation is an increase in the general price level. If you exclude a bunch of goods when you measure the general price level, you're not really measuring inflation. Everyday consumers have disparaged the "core inflation" notion so much, that Bernanke seems too embarrassed to even mention it by name anymore.

Now I'm going to say something that will make my fellow inflation hawks label me a heretic: core inflation does not significantly underestimate actual inflation in the long run. I have the data to prove it. According to BLS stats, over the last 20 years, CPI-U increased by a cumulative total of 67%; "core inflation" was only slightly lower at 63%.

Before Bernanke and Krugman erupt in cheers and "atta-boys," let me qualilfy what I said by adding: "however, it lags by 6 to 18 months." So this is really a bad thing. If headline inflation and core inflation are the same over the long run, and headline inflation is blasting at a 6% annualized clip, that means that "core inflation" has a helluva lot of catching up to do.

In fact, when you look at the data, that is exactly what "core inflation" has done in the past--caught up. That's because headline inflation is a good leading indicator for core inflation. The chart below shows smoothed half-year rates of headline inflation, along with core inflation lagged by 18 months.


(Click to enlarge) (Note the rates are low in this chart because they are half-year rates).

What to Do

Geopolitical panics and the concomitant spikes in Treasury prices are offering us lots of opportunities to short Treasuries. I avoid the 2X short Treasury ETF (TBT) because of its unacceptable leveraged ETF decay. So I'm shorting Treasury Futures and buying Treasury Future Puts instead. An alternative to Treasury Future would be to short one of the leveraged long Treasury ETFs, if that's possible. No doubt there will be many more little panics to come with the situation in Libya and an impending civil war in Yemen, so there's not a big rush.

The bottom line is, the 10-year note won't stay at 3.25% when inflation -- even core inflation -- exceeds that rate. And that's where we're headed within 18 months.

Disclaimer: I am not a registered investment adviser and do not give investment advice. I'm just some random guy on the Internet. You trade at your own risk.

Source: Time to Take Inflation Seriously