Friday, February 27, 2015

Looking Towards the Ides of March

Not surprising - considering the surge in the dollar since last summer, headline CPI for January posted its biggest drop since 2008 yesterday, falling 0.7% in January. Core CPI, however, exceeded expectations and rose 0.2% last month. The chart below that we've shared since last fall, shows 3 month Treasury yields less headline and core CPI (hashed), which has closely trended with the dollar - but with a several month lag. Despite the rise this month in core CPI, we expect to see more soft inflation data as the move in the dollar is further absorbed downstream.    
That said, we still view the reversal in gold last fall as a leading indicator of the inflation vane shifting north and look back at the more acute 2008/2009 deflationary impulse for reference - which also saw precious metals leading the pivot in the dollar and inflation expectations. This time around, the cycle has been more gradual, broader and shallower - but unfurling with similar dynamics between markets and asset classes. All things considered, we still very much like the prospects for gold and silver this year.

Since exhausting at the end of January, inflation protected securities have outperformed nominal Treasuries, following in the steps of gold and silver that pivoted higher roughly three months before.

Similar to the reversals in reflationary trends going into 2009, the latent pivot higher in the TIP:TLT ratio has also been made by markets such as copper and oil - which bounced roughly 10 and 20 percent, respectively, over the past month. A significant difference this time around has been the steady decline in the euro, versus a more broad and volatile structure of its low in 2008/2009.  


The U.S. dollar index is closing out February near its long-term 50 percent retracement high, which also serves as overhead trend line resistance from the July 2001 50 percent retracement high. As mentioned in previous notes, we expect the dollar to follow the lag in 10 year yields and back into the trough of its long-term range. 
The euro, however, appears poised to follow the current uptrend in U.S. 10 year yields and out of a trough low that's been tested over the past month. Similar to the lagged affect on yields from QE in the U.S. in late 2008, we expect the measures introduced by the ECB last month to begin to buttress European yields and the euro in March.
Outstanding of the oil crash in 2008, we have also closely followed the markets in relation to the supply driven decline in oil in late 1985 into 1986, which was primarily driven by a sluggish global economy while non-OPEC North Sea oil countries had increased production. Although there are similarities to what North American shale production has contributed to the global supply of oil, the 1985/1986 time period has been on our radar for years as a prospective mirrored shoulder in the
pattern below of the SPX:Oil ratio. Moreover - and quite dissimilar to 1985/1986, we feel the current move has been primarily driven by the currency markets, although there are similarities in underlying monetary policy that helped fuel a rebound in oil in the back half of 1986. 

While it was the Fed that eased aggressively in the first half of 1986, today it's two of the other major players in the balance of the global economy (Europe, China) that are loosening policy that should support a rebound in oil - as well as those markets that have contributed and correlated with its decline. E.g. - the euro and European yields.