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The Inflation Era Has Finally Arrived

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The Inflation Era Has Arrived! By EconMatters

IMF Says Inflation Pressures Non-Existent

The Federal Reserve isn`t the only one, everyone from the IMF, Bond Funds, Wall Street Analysts, Hedge Funds and the Big Banks are on the wrong side of the market both in terms of inflation already in the economy, current inflation expectations and being properly positioned or hedged for the inflation trade.

The Wolf has Arrived, but investors ignored the Inflation Data

We have tried to warn market participants even three weeks ago laying out what would happen to the CPI Data, and based upon many of the responses to our warning; the complacency on this issue regarding inflation is off the charts. The entire world is asleep at the wheel regarding bubblinginflation, when the stock market keeps putting in higher highs after a 35% year that should have been a warning sign that there is way too much liquidity in the system.

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We noted that normally the market would go down on QE tapering, and the opposite caught many hedge funds off guard who tried to seasonally short the market in late April, and it is apparent that runaway inflation in terms of excess liquidity in the system is what is pushing the stock market higher.

Above Trend Growth Equals Above Trend Inflation

But that is financial system inflation, we point to the stock market because that was a clue regarding inflation in the real economy that was well above what the trend had been the past 7 years. However, the PPI & CPI Reports for the last 4 months captured the above trend spike in inflation as well as the Employment Reports. Jan Hatzius, Goldman Sachs chief economist, says he believes the economy is now growing at an above-trend pace (see clip above). Goldman’s own current activity indicator is showing its fastest growth since the crisis, according to Hatzius. Well, we really shouldn`t be surprised that above trend growth brings above trend inflation pressures into the economy.

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It is obvious that everyone from the central banks to the yield chasing carry traders would want to discount inflation concerns in order to keep the proverbial party rolling along in terms of monetizing the debt at ridiculously low levels, and borrowing free money for eternity. But for every action there is a reaction, and it was only a matter of when and not if, that market forces, in this case higher inflation, would react to such an excessively loose monetary policy experiment.

The Massive Unwind & Fund Flows

Now that inflation is here the massive unwind will begin in anything from bonds, currencies used to initiate this yield carry trade, gold and silver, stocks and fund flows around the globe. There are a lot of crosswinds with markets like Gold, does it go up on inflation concerns and investors no longer chasing yield, or does it go down on rising interest rates and a strengthening dollar? This goes for stocks as well, do they continue to go up on inflation concerns and outflows out of the bond markets, or do they re-price on deleveraging of carry trades and raising rates for borrowing money?

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Sell Anything with a B in it!

The no-brainer is bond yields they are going up considerably from current levels, maybe slowly at first, but this slow upward trend will be punctuated by 10 and 15 basis point jumps in yields as resistance levels get taken out, and investors are forced out of positions that they fell entirely too much in love with regarding bonds in the era of easy money.

Key Technical Levels for the 10-Year Bond Yield

In the 10-Year we jumped from 2.59% to 2.65% today which is near the next resistance level which is 2.67% in yield. This is the key resistance level to watch in the 10-Year, once we break through this level 2.75% is the next major level of resistance. There is some resistance at 2.70% but this is a minor stop on the way to 2.75%. Once 2.75% is breached, the next resistance level on the 10 Year is 2.80%; this is the final barrier to hold before 3%. If 2.80% fails it is a straight shot to 3%, 2.80% is the last chance for any of the non-believers to get out before staring down a 3% yield in the 10-Year.

Once we break through 3% then 3.15% to 3.25% is the next area to watch, a breakout of 3.25% means 3.5% is a strong certainty as this yield train will be rolling. Investors probably cannot wrap their minds around how poorly positioned the market is for this change in yields, we could hit 4% on the 10-Year even before Fed Rate Rises justify such a move, just on a market squeeze and overshoot alone, maybe even 4.5% is possible given that the current market positioning on the wrong side of this trade is just that massive!

A Big Forest of Historical Knowledge

It is human nature to extrapolate recent history and postulate this trend going forward, or in other words to think entirely far too micro in terms of missing the big picture and lessons of history. Ben Bernanke has been extremely guilty of this with his “Not in his lifetime thinking” in terms of normalized rates.

Fundamental Laws of Nature Always Prevail in the End

At any rate, Interest Rates are going higher, whether people and investors like it or not, it is how markets work, even highly manipulated markets, because there are bigger fundamental truths that eventually play out called “Unintended Consequences”, and you can ignore them and even downplay them for a while, but eventually and as sure as the fundamental law of nature that everything has a cost, they make their presence known, and demand Center Stage, the Inflation Era has arrived!

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