January 06, 2010 |
|Commentary: Markets appear to have become more worried about inflation|
ANNANDALE, Va. (MarketWatch) -- Now for an update from the war between inflation and deflation: Inflation is gaining the upper hand.
That, at least, is what the markets appear to be saying. And if they're right, it means that investors can reduce their concern about the prospect of a deflationary collapse of the economy.
That's the good news. The bad news is that it means that investors also need to become more concerned about heightening inflation.
Consider how the markets have behaved since early October, three months ago, which was when I devoted a column to the unlikelihood of both gold and Treasury bonds continuing to rise together -- as they had over the previous several months.
Sure enough, since then the two assets have diverged markedly, with gold rising and bonds falling. To be sure, there has been a lot of volatility. But gold bullion is more than 8% higher than it stood three months ago, while the March 30-year T-bond contract has fallen more than 5% -- for a total divergence of more than 13 percentage points.
This means that both the gold and Treasury-bond markets are now speaking with one voice, unlike the situation that prevailed late last summer and early fall. And that voice is saying that inflation over the long term is becoming more of a threat, not less -- and that the prospects of a deflationary collapse in the coming years are lessening.
Another way of putting this: The markets appear to be betting that the Federal Reserve will be successful in its all-out efforts to avoid deflation.
Supporting evidence comes from the political futures markets, which have a surprisingly good track record at discounting all the available evidence: Based on the futures that trade at Dublin-based InTrade, for example, the risk of a recession in 2010 has fallen over the last three months from 40% to just 19%, where it stands today. The risk of one occurring in 2011 has fallen from 38% to 32%, and the risk of a recession in 2012 has fallen from 36% to 31%.
To be sure, not all the evidence points in the same direction. It never does, of course.
One piece of evidence that might not seem consistent with the worsening-inflation story: Rock-bottom yields on short-term Treasury bills. Those yields today remain barely above zero, almost precisely where they stood three months ago. And they briefly dipped into negative territory in late 2009, just as they did during the darkest days of the financial meltdown in 2008.
But while these low Treasury bill yields might be the result of concerns about an imminent deflationary collapse, they might also be the consequence of various liquidity considerations having nothing to do with the prospects for inflation or deflation. I am tempted to think these liquidity considerations are indeed the culprit, since none of the longer-maturity Treasurys are acting as though the risks of deflation are growing.
The bottom line? I recall a line often repeated by Martin Zweig, who used to be editor of two top-performing newsletters (both of which were discontinued in the early 1990s), and who then became the powerhouse behind several Zweig mutual funds and a regular panelist during the 1980s and 1990s on Louis Rukeyser's Wall Street Week television show.
He urged his clients: "Don't Fight the Fed."
By Mark Hulbert, MarketWatch