div align=”left”The biggest change in markets this year, and one generally overlooked, has been the disappearance of deflation risk. emstrongAt the March equity market lows, the year-over-year difference in the 12 month percentage return between stocks and bonds hit a historic milestone not seen in over seven decades. /strong/emThe return on stocks was so oversold relative to bonds that the degree of difference hit emstrongthree standard deviations from the historical average /strong/em(a very strong contrary signal, just as oil moving 3 SDs from its long-term average was a great sell signal last year)./divdiv align=”left”The chart below shows how the market’s expectation of future inflation has risen (implied inflation based on subtracting the real yield on TIPS from the nominal yield on Treasuries of similar maturity). At the end of last year the bond market was expecting to see roughly five years of deflation, followed by 5 years of modest inflation, adding up to almost a zero net change in the price level over the subsequent 10 years. Now the bond market expects inflation to average about 1.1% a year for the next 5 years, and 1.7% a year for the next 10 years./divdiv align=”left”While this marks a pretty dramatic shift in expectations over a short period, emstrongthe inflation discounted by bond prices today is still lower than it has been for the past 5 years, and lower than the inflation registered in any 10-year period since 1965./strong/em Rising inflation expectations are also evident in the steepening of the yield curve. Despite the Fed’s promise to buy up to $300 billion of Treasury bonds, long bond yields have risen steadily this year even as short-term rates have hovered near zero. emspan style=”color:#000099;”Recent comments by leading economists that the US needs to manufacture 6% or so CPI inflation to erode in real terms its massive debt burden (an eventuality I forecast a couple of months back) suggests that inflation risks are increasingly to the upside. So what are the broad investment implications?br //spanstrongspan style=”font-family:trebuchet ms;color:#3366ff;”This article continues at /span/strong/ema href=”http://www.deadcatsbouncing.com/”strongspan style=”font-family:trebuchet ms;color:#cc0000;”emwww.deadcatsbouncing.com/em/span/strong/a /divdiv class=”blogger-post-footer”img width=’1′ height=’1′ src=’//blogger.googleusercontent.com/tracker/1897020887579135393-9208892238063400712?l=deadcatsbouncing.blogspot.com’//divdiv class=”feedflare”
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Last 5 posts by Sean Maher

• Who was Smuggling $134bn in US Bonds into Switzerland? - June 12th, 2009
• Geithner Toxic Asset Plan Collapses: Will US Banks Follow? - June 10th, 2009
• US Unemployment hits 9.4%...that's Bullish, Right? - June 5th, 2009
• Oil Price Surge: Deja Vu? - June 3rd, 2009
• China Hedges Against US Inflation... - May 28th, 2009