Revisiting Inflation: Consumer Prices and the Fed

Includes: GDX, GLD, TLT, UUP
by: Rob Viglione

The verdict is not yet out as to whether we will experience inflation or deflation in the near term. The argument has been raging with pundits on both sides clinging to data they claim supports their guesses. Yesterday marked a big day in the debate, however, with two critical pieces of news:

  1. Consumer price index (CPI) rises more than expected, up 0.4% in Feb. following a 0.3% gain in Jan. This represents at 4.8% annualized inflation rate.
  2. Federal Reserve committed to buying $300 billion in long-term Treasuries as part of its plan to drive consumer borrowing costs lower.

The immediate fallout can be seen in gold, the U.S. dollar, and Treasuries. Both pieces of news are inflationary. Rather than the feared ‘deflationary spiral’ we’re starting to see consumer prices heat up, albeit not appreciately just yet. The Fed buying Treasuries amounts to them printing $300 billion in new currency. This money is created out of thin air.

Most telling on inflationary fears is the Market Vectors Gold Miners ETF (NYSEARCA:GDX), up over 10% yesterday, while the SPDR Gold Shares ETF (NYSEARCA:GLD) approached a 4% gain. PowerShares US Dollar Index (NYSEARCA:UUP) dropped over 3%, and the 30-Year Treasury yield fell to a low of 3.37% after the Fed announcement, settling higher at 3.57% later in the day.

In Checkmate: How the Federal Government Will Lose in 2009, I argued that our leaders were backing public finances into a predictable corner. With $2-3 trillion in budget deficit for 2009, alone, with more planned in coming years, government will be forced to increase borrowing or printing. Yesterday’s news supports the ‘printing’ hypothesis, but I suspect this is just the beginning. The big game unfolding will be the Treasury issuing bonds to raise funds and the Fed turning around and buying them. This is a scam that will either lead to increasing bond yields or increasing inflation. There are no other options.

Disclosure: Author holds long positions in GLD and GDX and a short position in TLT.