By and large, appraising inflation and its considerable influence within the markets has been the Mavericks of macroeconomics for this cycle. Although we've personally taken some nice long rides on market ideas closely tied to our own inflation expectations, we have also been on the receiving end of leaving too early and feeling the weight of a position move against us. Nevertheless, it is what makes markets, markets - forever fascinating and always a challenge to navigate. Catch a big swell and you feel like you've bridled mother nature. Remain "in the zone" and you run the risk of losing some healthy humility towards the hand that feeds you. The challenge is always to keep riding and learning, with a heavy appreciation of the larger forces at play that will inevitably come down upon you at some point.
When it comes to those forces, we are looking for yet another counterintuitive outcome in the wake of when the Fed finally moves off of ZIRP. Whether it's this afternoon - which appears highly likely, or early next year, we expect financial conditions to loosen globally as the Fed steps policy back away from the crisis stance it's maintained over the past seven years. From a behavioral point of view, QE and ZIRP have not been considered a positive station for the markets for some time; rather much the opposite - a confirmation in the belief that the economy still requires further external support. From a market perspective, maintaining current policy has been in and of itself - disinflationary. As inflation has fallen, real interest rates have risen.
The long and short of things, we believe assets that have taken the brunt of this extended normalization (e.g. precious metals, commodities, emerging markets) remain at the very least attractive mean reversion candidates (i.e. Dornbusch's overshooting hypothesis), with potential bullish asymmetries if our expectation that inflation will surprise to the upside. The silver:gold ratio, which in the past has been an excellent proxy for reflationary forces, continues to flash a rare positive momentum crossover (Figure 3). Moreover, the bullish comparative pattern in equities from 2011 (Figure 4) also points towards a broader reflationary path in the near-term, and a break from the replicating disinflationary patterns found in sensitive assets such as the precious metals miners (Figure 5). Just as the banks were largely value traps up until Q4 2011, we suspect the miners will finally have their comparative pivot (Figure 6) towards more benevolent market conditions.