Inflation vs Deflation

Inflation vs Deflation, What Comes Next?

If you have been following the Stock Markets, and particularly, the fundamentals, you have heard the word inflation be mentioned once or twice. Who am I kidding! That’s all everyone talks about!

A large part of this has to do with the Federal Reserve. Markets want to know when the Fed tapers and decides to start raising interest rates. If the economy is recovering, we should expect this sometime in the future. The end of 2023 to be exact, although other Fed Presidents believe rates may need to be raised sooner due to inflation.

Why does this matter? When inflation is rising, the central bank raises interest rates to cool down the economy. When the economy is not performing well, the central bank cuts interest rates to spur it. Most of my readers are familiar with this concept.

Inflation data currently is making records. We are seeing 5% CPI and PPI data come in. But the Fed is saying that this inflation is transitory. Meaning that this inflation stems from re-opening of the economy. More people are buying goods, and the supply chains need to catch up. Once consumers transition from spending money on services rather than goods, this temporary transitory inflation will disappear. In this environment, the real inflation will come in below 2% which meets the Fed’s threshold. The financial media buys this. I am not so sure others do.

Billionaire hedge fund managers (some still active) such as Ray Dalio, Stanley Druckenmiller, and Paul Tudor Jones have come out sounding the alarm bells on Fed policy and the inflation trade. The Fed will need to raise rates sooner rather than later to avoid major inflation. But, the markets seem to be calling the Feds bluff. Everyone knows the current market environment is all about speculation. Cheap money from the Fed helps. The party keeps going.

If the Fed was going to raise rates, many expect the stock markets to fall. They would take a big hit on the taper tantrum. This could be the reason the Fed does not want to raise rates, because of the potential financial crisis that could snowball. Leveraged trades, pension funds, major banks could be affected on a large stock market decline which would trigger a crisis. Some say the Fed is trapped, and transitory inflation is a way for them to delay rate hikes. Not withstanding the fact that there is more debt out there, so a rate hike would make payments more expensive for consumers and for government. 

I have always said that inflation is coming. Currencies are getting weaker, hence it will take more weaker currency to buy something. Which means prices rise. This also plays into the currency war between central banks. All of them are trying to have a weak currency to inflate and boost exports.

Another reason why inflation is already here is to do with money supply. We are now in a situation where there are people with more money competing for the same number of goods and services. Partly due to government checks, but also the fact that nobody wants to go back to work. Productivity is key to this. I’ve talked about this in the past, but a lot of conversations people are hearing on golf courses between young people is how they will not go back to work. They have made more money trading stocks and crypto’s. 

But now I want to entertain a 180 turn to all of this. What if the markets are wrong. What if deflation is the real threat and NOT inflation?

I came across Alessio Rastani’s video lately and it got me thinking. As my readers know, I am always watching the Bond markets, the US Dollar and Gold. These markets have been having some mixed inflation signals recently. And the technicals add more drama to this whole thing. More on this in just a sec.

To summarize Rastani’s video, Inflation signals are:

  1. Rising Interest Rates (A Fall in Bonds).
  2. Rise in Foreign Currencies (The Euro, Loonies etc) or another way to put it, the Fall of the US Dollar.
  3. Rising Gold Prices.

Deflation Signals are just the opposite of above:

  1. Lower Interest Rates (A Rise in Bonds).
  2. Rise of the US Dollar.
  3. Falling Gold Prices.

I have always been a contrarian. I think those that are wealthy tend to be. They don’t make their money following the crowd, they do the opposite. So when I came across this contrarian viewpoint, it caught my attention. The financial media is all about inflation, inflation, inflation. This is a sign that we should be considering the opposite. Let’s see if our contrarian viewpoint has some validity. Let us take a look at these charts one by one.

Above are the Daily charts of the US 10 year yield and bonds. I chose TLT but you could also look at BND. So remember the inverse correlation between bond yield and bond price: when yields drop, bond prices rise and vice versa.

Looking at the 10 year first, do you all remember when the rising 10 year yield was spooking financial markets? Interest Rates were rising, fueling perma bear doomsday market crash scenario’s. Now we don’t hear too much about it. And for a good reason. The 10 year yield had to hold above 1.50% for further upside momentum. This did not happen. We have not closed below 1.50%, and it looks like yields are heading LOWER.

Secondly the TLT. And folks, this might be the important macro chart for the next few months. We have triggered an Uncharted market structure pattern. We would be going long, and expect more upside as long as TLT remains above 140. This means higher bond prices. This is big for two reasons. First, it ticks a deflation criteria box. Secondly, it will test the asset allocation model. Money tends to run into bonds when there is a risk off environment. Meaning money will LEAVE stocks for bonds. Perhaps this is signaling an event in the near future which will cause money to run into bonds. Deflation anyone?


Above is the weekly chart of the US Dollar Index, the DXY. Currently, we are in some Dollar trades based on the daily chart meeting Uncharted Market Structure criteria. But the weekly chart is hinting to further Dollar strength.

The 89 zone is major support. The Dollar found support there which it built up for weeks, before shooting higher. It seems like a double bottom pattern is in the works. Once again a bit worrying as Dollar strength generally means something is coming down the pipeline. Money flows into the Dollar when things are uncertain. It is a safe haven currency. OR, the Dollar can finally be playing out as I have said months ago. In this currency war, the Dollar is the best fiat out of the bunch.

This week and month will be big for the US Dollar. If we close below 90.50 on the DXY, then the deflation criteria for the Dollar becomes challenged. But as of now, the new uptrend is still in play meaning another tick on the deflation criteria.

Last but not least, Gold. This is where things get a bit murky. Now as a trade, I think there is some upside for Gold that could occur this week. But we want to focus on the longer term. If interest rates drop, this is positive Gold. But conversely, the prevailing thought is that a stronger dollar is negative for Gold. I still believe money can run into bought the Dollar and Gold if there is a confidence crisis (people begin losing trust in government, central banks and fiat currency). Everything macro is pointing to higher Gold prices even with a rising Dollar. 

Looking at the weekly chart, Gold is a bit tough to analyze. It looked good with us breaking a flag/pennant pattern, but we have closed below the retest, so the pattern is now invalid. You can see I have a major flip zone where Gold is currently. This 1775 zone is key. I will be watching this weeks close closely to determine whether Gold continues to move higher, or we are dropping further. 

In summary, the deflation claim by Alessio Rastani has technical support. When I see bonds and the US Dollar rising, I automatically think a run into safety. Fear. Perhaps this fear has to do with the pandemic, or maybe money is pricing in deflation.

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Vishal Toora

Vishal Toora

Vishal is an avid market analyst, geopolitical junky and wealth management strategist. As the founder of UnchartedFX, Vishal has over 7 years of live market experience with real money accounts. Originally an archaeologist by career, Vishal decided to pursue trading full-time in 2014 because of the freedom and financial stability awarded from the worlds financial markets successfully.

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Inflation vs Deflation

Inflation vs Deflation, What Comes Next? If you have been following the Stock Markets, and particularly, the fundamentals, you have heard the word inflation be

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