While Cyprus has been brushed away as a "storm in a teacup" and asset-gatherers stare blankly at their screens pointing at record highs to confirm the "market knows best", it appears something rather important 'broke' that day (and hasn't stopped breaking since). While we have discussed the rather glaring divergences between US equities' exuberance and global equity markets and macro- and micro- data; supposedly the Fed's key indicator (the 5Y5Y forward inflation expectation) has reversed rather significantly. The last two times, forward inflation expectations dropped so significantly, the ECB launched LTRO and the Fed launched QE3. It seems the BoJ's QQE is not having the effect perhaps they had hoped on inflation expectations. Will the Fed have to come to the rescue once again? And how will gold react to that?
Cyprus appears to have stolen the jam out of the reflation-game donut...
as one of the Fed's key indicators (5Y5Y forward inflation) is diverging significantly... suggesting multiple compression (not expansion)...MORE
And from FT Alphaville:
Have the inflation-paranoid capitulated?
Thursday’s 5-year US Treasury TIPS auction was something of a noteworthy one, according to Kit Juckes at Societe Generale. Click to enlarge…
As the results page shows the auction ‘stopped’ at a yield of -1.311 per cent.One of the standard measures applied to any trending price series is the momentum of the price change (acceleration/deceleration), a second derivative. It is handy for calling turning points.
But what’s more interesting according to Juckes is the following (our emphasis)
In the language of bond auctions, it had a low bid/cover ratio, a long tail and was a bit of a mess! A 3 year history of 5yr real yields (TIPS), next to conventional 5yr Treasury yields and the difference between the two (break-even inflation) provides some context: In October 2008, 5yr real yields reached 3.2% and on April Fools’ Day 2013, they reached -1.77%. We have seen a very sharp correction of a small part of that long fall in the last two weeks. 5yr conventional Treasury yields have also fallen since 2008, of course. But since the start of this month, conventional yields have actually fallen a little further, as soft US data is interpreted as either a temporary soft patch for the economy or the end of a temporary period of strength. We, of course are firmly in the former camp. The result though, is that the rise in real yields is matched by an equally sharp fall in breakeven inflation rates. 5yr breakeven inflation rose for a distorted low of -0.5% in October 2008, to almost 3% in 2011, but in this month alone we have seen a fall of 0.6% to 1.95%.So what we’ve seen is a perfect storm for TIPs, which obviously look much less appealing when the prospect of deflation raises its ugly head.
Whether this is a position-driven adjustment or capitulation by those who fear that current monetary policies must inevitably lead to an outbreak of inflation, it looks very like a series of dominoes falling over.
The key point really, however, is that with conventional yields unable to go anywhere but sideways — because of the zero lower bound — falling inflation expectations have no way to express themselves other than in TIPs....MUCH MORE
Imagine a ball tossed into the air: It will ascend at slower and slower speed until it stops heading up and gravity takes over.
I had not been paying attention to gold last year until I saw a post by the author of the FTA post above, Izabella Kaminska: "Capping the gold price" which pointed out the relationship between TIPS pricing and gold and most importantly that the ascent of gold prices was capped.
As in our airborne ball example, if you can detect the slowing of the upward momentum you have a fighting chance of catching the change in direction.
"Capping..." was posted on Dec. 7, 2012--five days before gold hit it's intermediate term peak of $1715.
A couple days ago it traded as low as $1321.50.