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U.S. Inflation Could Hit 0% By June, 1% By Year End - Avoid Gold

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Includes: AAAU, BAR, BIL, DFVL, DFVS, DLBS, DTUL, DTUS, DTYL, DTYS, EDV, EGF, FIBR, GBIL, GLD, GLDM, GOVT, GSY, HYDD, IAU, IEF, IEI, OUNZ, PHYS, PLW, PST, QGLDX, RINF, RISE, SCHO, SCHR, SGOL, SHV, SHY, SPTI, TAPR, TBF, TBT, TBX, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UDN, USDU, UST, UUP, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: Jason Tillberg
Summary

January inflation data shows continued downtrend in year-over-year % change.

Recent loan demand data continues to suggest slow aggregate credit growth which will help to keep inflation lower.

Strong dollar and lower commodity prices are paving the way for very low inflation ahead.

Real rates of return will only grow wider as inflation subsides.

Gold is one asset to avoid as I don't believe it has yet figured this out.

I created this chart of my forecast for inflation for 2019 back in January.

2019 inflation forecast The red bars are my forecast numbers.

Today, we got January's Consumer Price Data and they came in at 1.52% year over year.

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIAUCSL, February 13, 2019.

This was lower than I was forecasting.

My forecasts for the year over year change are as follows:

  • January 2019: + 1.70%
  • February 2019: + 1.40%
  • March 2019: + 1.00%
  • April 2019: + 0.70%
  • May 2019: + 0.40%
  • June 2019: + 0.00%

For the second half of the year, inflation should pick up again but only to rise up to 1.00% by the end of the year. Of course, things could change and we have to be nimble on anything further out than even 3 months time.

Back on November 26th, I wrote an article titled "Prepare For Deflation In 2019" and wrote the following:

I'm becoming more and more convinced that we are headed toward lower inflation and that the Fed will be lowering interest rates in the not too distant future to try to stimulate loan demand again. Also, to reduce the debt service expense.

iShares 20+Year Treasury Bond EFT (TLT) offers investors both a decent yield of 2.86% at the current price of 115.14 per share, but also price appreciation potential in the event that interest rate decline.

With today's inflation report, coupled with recent data on loan demand, I remain confident in my forecast of lower inflation, out to at least June.

One standout is the net percent of banks that reported stronger demand for credit card loans:

Demand for consumer loans in particular is waning and that helps keep a lid on inflation.

Disconnect Between This Forecast And What Market Expects

I appreciate that nowhere will you find such a low forecast for inflation in 2019.

The Congressional Budget Office, or CBO, has an expected rate of inflation for 2019 at 2.1% and jumping to 2.6% in 2020. This is the CPI index of all urban items. That is more or less in line with most other forecasts for inflation for 2019, around 2%.

How Markets Would Respond To Surprise Lower Inflation

First and foremost, lower inflation, with the level of employment and wage gains we currently have, will be a boost to the US consumer as purchasing power would rise and standards of living should improve.

Real rates of return will be had from any interest bearing security that pays a higher rate of interest than the rate of inflation.

Savers can rejoice as the Fed raised rates to now 2.4% and earnings on short term securities like 3 month treasury bills are now paying 2.37% vs. an inflation rate of just 1.52%.

Here is a 10 year chart of the real rate of return on 3 month Treasury's:

As the rate of inflation declines, the real rate of return will rise even more.

This should prove well for the overall economy and helps to explain why Americans' confidence about their own finances reached an all-time high.

Gold

Gold (GLD) as an asset works best when thought of as protection against confidence in both Government and money itself. One metric of that is the real rates of return offered on money.

Here is a 10 year chart of gold via the Gold ETF, GLD:

If you notice, the big runup in 2011 was the same year when we saw the deepest negative real rates of return on the 3 month Treasury bills per the chart right above.

It was in late 2015 when inflation was near 0%, although so was the Fed funds rates, but real rates of return peaked their head. By the end of 2015, gold bottomed.

What happened in 2016 was a return of inflation, with the Fed only just beginning to raise rates, the real rate of return became negative again, thus boosting gold prices once again.

I suppose gold has been basing trying to figure out what comes next.

I don't think gold has figured out yet that real rates of return could spike higher in 2019.

Upon figuring that out, I would think the chances of gold turning down are higher than the chances of gold moving higher. Inflation running low and providing everyday Americans with a strong currency to purchase their goods and services boosts confidence.

For now, the dollar is very strong and should remain stronger year over year for the next few months especially. I would put gold as the one asset to both avoid and or play to the downside as inflation subsides and real rates of return rise.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.