Keystone's Inflation-Deflation Indicator Signals DEFLATION

About six weeks ago, the U.S. slipped into disinflation and one-month ago the U.S. slipped into deflation. The equity markets manage to pump out new highs on the Fed's QE 4 Infinity and Beyond, as well as money fleeing Europe and moving into U.S. blue chips, for the last couple weeks which moved the U.S. back into disinflation. However, as of today, the U.S. is firmly in deflation, what Chairman Bernanke fears most. The 10-year yield (now 1.82%) moves in the same direction as the equity markets since money moves from stocks into bonds and from bonds to stocks depending on risk-off, or risk-on, respectively. Higher yields = higher stocks = a move towards inflation. Lower yields = lower stocks = a move towards deflation. The 10-year yield was well over 2% one month ago.

The note price is used for the denominator of Keystone's equation. The 10-year Treasury price is 101.656. The CRB (Commodities Index) is under 290 at 289.77. Taking a look at the numbers;

CRB/10-Year Price = 289.77/101.656 = 2.85

Over 4 = Inflation
Between 3 and 4 = Neutral; Inflationists and Deflationists fight it out
Between 2.9 and 3.0 = Disinflation
Under 2.9 = Deflation

Chairman Bernanke announced QE1 in 2009 and QE2 in 2010 as the country became mired in deflation with Keystone's indicator in the 2.5-2.6 range each time. The indicator dipped into this area in May 2012 but then recovered when the central banksters started pumping again.  The oddity was that the ECB's OMT Bond-Buying program and the Fed's QE3 announcements in early September 2012, and even QE4 announced in December 2012, that replaced Operation Twist, occurred when the stock market was already elevated. Bernanke used to wait for deflation to surface before announcing QE measures, but not anymore.

The prior stimulus measures (QE1, QE2, Operation Twist, LTRO 1 and 2) all occurred when the markets slipped into deflation (under 2.9) so that expected trend was broken for QE3 Infinity and QE4 Infinity and Beyond.  It smacks of desperation, a 'throw the kitchen sink at it' approach.  Bernanke fears deflation since he is a student and scholar of the The Great Depression.  Bernanke says the Fed did not act quickly and forcefully enough in the 1930's.  Hence, he has the nickname Helicopter Ben since in a speech a few years back, Bernanke said that money should be dropped from helicopters to stop a deflationary spiral.  Japan's deflationary spiral is now in its second decade and they have recently cranked up the printing presses and will try to inflate their way out by weakening the yen. But Bernanke's economic experiment may hit a road block in 2013 since the velocity of money is not increasing and now all the major countries are in a race to debase their currencies. In other words, the QE will not have the desired effects and in fact create major turmoil a few years from now when hyperinflation hits.

Keystone's indicator is now signaling Deflation. The pundits and analysts that say Inflation and even Hyperinflation are at the doorstep are likely premature.  Inflation will likely not appear until two, three, or even more years down the road to line up with the 18-year stock cycle of 1964 (bear), 1982 (bull), 2000 (bear), and 2018 (bull). That will be a new and intense problem, especially hyperinflation, but for now, the disinflationary and deflationary scenario's remain more important despite the new daily highs in equities. Look at Japan's funk for the last twenty years; deflation can be nasty and will surely affect everyone's lives.  Layoffs continue in the U.S. and globally with tens of thousands of financial and insurance sector jobs cut over the last couple months.  The current stagnant wage growth (wage deflation) screams of deflation.  Technology, computers and the Internet are huge deflationary machines.  Robots continue to replace human's on the job. More tech and less human's continues to challenge the unemployment picture and will foster the structural employment problem for many years.

Watch Keystone's formula above, you can crunch the numbers to check on the indicator every few days. Markets are in trouble when the indicator drops under 3.00 into Disinflation.  Equity markets are going over the falls if 2.90 fails since it indicates a deflationary spiral is occurring and the U.S. is headed straight for a Japan scenario.  As long as the indicator stays above 3.0, in the Neutral territory and higher, the equity market bulls are happy. Watch the copper, oil and commodities markets closely since they should lead equities lower.