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Is Inflation Spike Transitory?

Prices on almost everything from copper to crude oil have skyrocketed over the past year. So, is the recent surge in prices inflationary, and is it sustainable or transitory?


The question is hard to address as there is no precedent in the postwar period where there was a simultaneous economic crisis coupled with a global health care pandemic. The global economy went from a depression (global shutdown) to a war-time boom, literarily overnight (2-months of recession).


The concerted efforts from central banks and governments to stimulate their respective economies with massive monetary and fiscal policies may have prevented a global depression. But it has also led to a surge in prices, hence the spike up in inflation.


Chairman Powell and the Fed believe the recent rise in inflation is transitory. Many economists also believe inflation is temporary as disinflationary forces remain the dominant theme. The Fed and the US Treasury Department reiterate that monetary and fiscal stimulus will not lead to rising inflation, long-term.


Long-term demographic and economic trends will also keep a lid on any inflationary forces. Technology and innovations are great disruptors resulting in greater productivity, lower labor costs, and lower inflationary pressures. Slower labor force growth, aging populations, and the opening of the global economy are disinflationary forces, longer-term.

The most common measure of inflation remains the Consumer Price Index (CPI). CPI consists of a basket of goods such as consumer goods and services, health care, and transportation expenses. Economists and investment professionals typically follow this basket closely to understand the purchasing power of the US dollar. Others will closely track interest rates, wages, unemployment, and commodity prices such as WTI Crude Oil, Copper prices, Gold, and industrial metals to gauge the economic conditions.


The recent sharp and sudden rally in CRB from a low of 101.48 (4/21/20) to a recent high of 221.25 (7/29/21) may be another "Inflationary Spike." There have been a few of these explosives but unsustainable spikes in the past (i.e., Nov 2001-Jul 2008 and Mar 2009-Apr 2011). CRB may be nearing an inflection point once again. The ability to convincingly surpass above 215-220 or the top of the long-term secular trendline confirms real inflation. However, failure to clear the key resistance may lead to nominal inflation or the resumption of the disinflationary trend.


Martin Pring, a famous Technician, developed the Pring Inflation Index. The index consists of predominately mining and energy stocks. These stocks tend to excel when the economy is strong and growing. The Pring Deflation Index is a basket of deflation-sensitive stocks, namely financial companies, banks, insurance companies, and utilities. These stocks tend to excel when the economy is weak or during the early phases of an economic recovery.


The Pring Inflation Index/Deflation Index is simply a ratio of the Pring Inflation Index divided by the Deflation Index. A rising ratio suggests rising inflation, and a declining one signals a deflationary environment. Historically, the indicator can lead the commodity market at both peaks and troughs.


The Pring Inflation/Deflation ratio (0.25) suggests a continued trading range between 0.157-0.169 and 0.271-0.290, evidenced by the 5-year symmetrical triangle pattern. A breakout above the top of the triangle at 0.271-0.290 and 0.309-0.325 (1998 low and 2016 high) warns of higher inflationary pressures. Below 0.157-0.168 confirms a breakdown and the resumption of deflationary pressures. Could the indicator remain confined to the 5-year trading range, signaling nominal inflation?


Some believe the historical breakpoint occurs when real yields approach the 2% level on the 10-year Treasury. The 2% level has been the inflection point over the last 70-plus years. Since real yields are negative today, it would imply there may be more room for yields to rise before equities begin to feel the effects of higher real rates.


Contrary to popular beliefs, the 10-year Breakeven Inflation Rate is not a predictor of future inflation. Instead, it is a market-based measure of expected inflation in the future. The rate is the difference between the yield of a nominal bond (i.e., 10-year yields) and an inflation-linked bond of the same maturity (10-year). The latest value (2.38 – 8/3/21) implies what market participants expect inflation to be in the next ten years, on average.


Nonetheless, investors are closely tracking the 10-year Breakeven Inflation Rate. The rate has risen from 0.50 at the height of the Covid-19 pandemic (3/19/20) to 2.54 (5/10/21, 5/12/21, and again on 5/17/21).


The enclosed chart of the 10-year Breakeven Inflation Rate from the Federal Reserve dating back to 2002 shows that this has been one of the sharpest accelerations in the past 13-years. The last time we witnessed a similar jump of this magnitude was during the 2008-2010 timeframe. The 10-year Breakeven Inflation Rate rallied from a low of 0.14 to a high of 2.38.


It is also important to point out that historically the Breakeven Rate tends to peak at 2.64-2.74. For instance, during 5/24/04 (at 2.74), 3/21/05 (2.73), 5/15/06 (2.68), 4/14/11 (2.62), and 9/14/12 (2.64).


Did the 10-year Breakeven Inflation Rate already peak at 2.54 during May 2021?


And if this is a peak, does this support Chairman Powell and the FED's call that inflation is transitory?


In summary, the above analyses, including the CRB Index, Pring inflation/deflation indicator, and 10-year breakeven inflation rate paints a mixed inflationary outlook, neither confirming nor refuting the call of long-term inflation in the future. However, CRB Index is approaching an inflection point, while the 10-year Breakeven Rate may be peaking, and the Pring Inflation Index/Deflation Index ratio continues with its sideways trading range. A modestly rising inflationary trend is good for the economy sustaining the current stock market bull rally a while longer. An economy that is neither too hot nor too cold (goldilocks environment) will keep the Federal Reserve on the sidelines.


Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of Federal Reserve Bank of St. Louis (fred.stlouisfed.org)

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