In early October, we put together a presentation to make our case that we may be headed for an inflation surprise when everyone is still glued to their deflationary fears in an article titled: An Inflation Surprise - Invoking Volcker. If you haven't had a chance to see the presentation, we encourage you to.
Our view is that we could be due for an inflation surprise. Interest rate sensitive assets (IEF, PST, UST, TBX, TIPX, IMTB, TYNS, DXKLX, SYTS, DXKSX, TLT, TBT, TMV, IEF, SHY, TBF, EDV, TMF, TTT, PST) could be vulnerable, the slope of the US yield curve could steepen quite dramatically, and the reflation trade (BCX, COMT, CSFSX, CORN, SOYB, WEAT, NIB, CHOC, NBC, JO, CAFE, SGG, CANE, GLD, GLDX, GLDI, GLDW, SLV, SIL, SPY, SPYG, SPYV, SPYD, SH, VXX, SVXY, VOO, IVE, NDAQ, QQQ, NASDX, VXX, VIXY, VIXM, VIXH, TVIX, UVXY, VTI, PFF, VTSAX) could be back with a vengeance.
Our hypothesis was that while the core CPI was still subdued, underlying inflationary wage pressures were building up and that this could be a precursor to higher inflation and higher yields in the future.
Producer Price Index (PPI) data for October was just published and the total PPI and the core PPI both beat expectations.
YoY rate of change of US PPI showing a nice bottoming pattern:
YoY rate of change of US Weekly Earnings and Weekly Hours worked both rising:
Smoothed US 5 year forward inflation expectations continuing to rise:
US 10-2 Year Treasury yield spread is still flattening but is this sustainable if inflation starts rising and long term yields start reflecting that? We don't think so.
While technological innovation in robotics and Artificial Intelligence will surely act as long term deflationary forces, we are of the view that a perfect recipe for a near term inflation surprise is being concocted right in front of our eyes:
- 1 part tax cuts.
- 1 part infrastructure spending.
- 1 part protectionist trade policies.
- 1 part dovish federal reserve.
- 1 part rising wage pressures.
Mr. Volcker, where are you?
Disclaimer: Rigel Mercantile Limited specializes in Macro/Value Research and Systematic Trading. The views expressed above are our discretionary ideas that we have arrived at using discretionary analysis and, therefore, are limited to our discretionary portfolios only. Our systematic strategies may or may not have a position (long or short) in the securities mentioned above. Under no circumstances should the information contained herein be used or considered as an offer to sell, or a solicitation of an offer to purchase, any security or investment service. The information presented herein is presented in summary form and is, therefore, subject to qualification and further explanation.
Disclosure: I am/we are long LONG AGRICULTURAL COMMODITES, GOLD, US EQUITIES.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.