Earlier this month, the US Treasury announced plans to flood the financial system with cash by reducing its balance on its general account through the Fed.
The Fed will continue with its Quantitative Easing, which combined with the Treasury's plans, means an inflation of the money supply totalling more than a trillion is in progress. Note that this doesn’t include Biden’s planned stimulus of $1.9 trillion. This, combined with the recovering US economy due to vaccination efforts will definitely inflate the economy.
To put things into perspective, let’s look at the M2 Money Supply…
Here are the yearly M2 averages from various dates
M2 Yearly Average1960 - 20192000 - 20192010 - 2019
Compared to the change since January 2020…
M2 % ChangeJan-2020 - Feb 202
Source: Fred St. Louis
That’s the largest YoY % change since 1960!!
Inflation is definitely coming whether you like it or not.
This led to traders betting that the US inflation surging in the short-term.
The 5-year inflation rate is above the 10-year inflation rate for the first time since 2008.
Well, if you’re asking if it will still continue, here are some data that suggest so…
Given the past correlation between Kansas City Fed Raw Materials Price vs PPI YoY %, PPI has lots of catching up to do which indicates a higher level of inflation. The Empire State Manufacturing Survey Current Prices Paid vs Core PCE YoY % is painting the same conclusion as well…
Source: Kansas City Fed, Fred St. Louis
Source: Federal Reserve Bank of New York, Fred St. Louis
With inflation rising, obviously, yields will have to rise to counter it.
The MOVE Index saw a rise of 37.9% since 16 February 2021.
And is reflected on the US10Y being at its yearly high.
With the GB10Y also at its high since July 2019
Similarly, it’s not just in the US but global yields have been on the rise…
Just like the inflation example before, here’s another chart that could mean catching up. Well, the US 10Y Rate could go up or 10Y BE inflation rate could go down or maybe they’ll meet somewhere in the middle. Either way, we feel that it is likely that yields will continue to go up at least for the very short term.
Source: Fred St. Louis
And of course, in this current condition, the DXY is on the move…
The DXY has failed to break out of the kumo 3 times on the daily for the recent 12 months (pink circle), 1 false breakout (orange circle) and the last successful breakout was 13 March 2020 almost exactly a year ago. With the continued rise in yields, a breakout of the kumo and its current 50 EMA can see prices up to the 92.8 levels. Important to note that the last breakout lasted from 16th to 29th March before the downtrend of the dollar began. In context, S&P 500 bottom was on the 23rd of March. Just after the US Administration asks Congress to send Americans Direct Financial Relief on March 17th and CARES act being approved on the 27th of March.
The stock market too was affected, it has been getting a beatdown for the past week.
The S&P 500 has been going down since its high of 3950 on 16th February. However, price is currently supported by the bottom of the channel with confluence of both the 50 EMA and kijun-sen supports. Should this level fail to hold, we expect another strong support at 3779 which is the kumo support.
When looking at the S&P 500, we obviously have to look at the VIX. It was interesting to note that February 25th saw a VIX daily increase that was the 24th largest since 1990. Even though it pales in comparison to January 27th’s VIX increase which ranked 3rd, we should expect higher volatility ahead from a VIX above 20 and rising.
Source: CBOE, Mercurial Research
So how do we position ourselves for a market expecting rise in interest rates and inflation?
Obviously, inflation hedges such as copper and steel are advised.
Gold has traditionally been an inflation hedge but as of now the near-term rise in yields and the dollar overwhelms the longer-term implications, at least for now. It is currently having its worst monthly performance since 2016. However, we do see long-term prospects in gold.
Here’s a chart of Gold vs US10Y (inverted), a stabilisation in yields could lead to a reversal in gold prices. As of now, price is attempting to break below the 0.5 fib and an increase in US yields could be just the only trigger it needs for the successful breakout.
And here are some helpful data regarding allocation in such times according to JP Morgan. Below are the top performing asset classes when inflation is rising according to them.
Source: JP Morgan
Goldman meanwhile believes its Oil.
Source: Goldman Sachs Investment Research
For equities, we advise looking for companies that deal with inflationary products and in a market like this, a rotation to value stocks is an obvious move as low rates discount cash flow on growth stocks favourably so when rates rise it puts pressure on growth stocks causing a rotation to value.
And from a technical perspective, looking at the TLT, it recently triggered a TD countdown 9 on the 25th of February and closed on the 800 EMA. Likewise, the US10Y is near its 800 EMA and currently around the 0.382 fib. Stabilisation in the TLT and US10Y will see a rotation back into value stocks.
All in all, fundamentals still point to more upsides to inflation and yields. However, technicals are signalling the possibility of a short-term reversal. A decrease in exposure due to expected volatility and inflationary hedges such as oil, metals and value stocks are advised going forward in the current economic environment.
The information, tools and materials presented are intended for informational purposes only and are not to be used or considered as an offer or solicitation to sell or an offer to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities, investment products or other financial instruments. This research report is prepared for general circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should independently evaluate particular investments and consult an independent financial adviser before making any investments or entering into any transaction in relation to any securities mentioned in this report. Our analysis is based upon information gathered from various sources believed to be reliable, but such accuracy or completeness can not be guaranteed. The publisher and/or its individual officers, employees, or members of their families might from time to time have positions in the securities mentioned any may purchase or sell these securities in the future. No part of this publication or its contents, may be copied, downloaded, stored in a retrieval system, further transmitted, or otherwise reproduced, stored, disseminated, transferred, or used, in any form or by any means, except as permitted or with prior permission.