Blindsided!

“Markets Will Be Blindsided by Inflation’s Comeback.”

We were sorting through the indrift of news this morning… when this headline seized us by the throat.

Inflation’s comeback?

Is not inflation in swift retreat? Is not inflation nearly routed and licked?

We are informed that it is, and informed of it each day.

Inflation (official inflation, that is — the caveat is necessary) summited last June — at 9%.

Today inflation pegs along at 3.2%.

That is a mighty coming-down within the space of 13 months.

The Federal Reserve nearly has the tiger by the scruff, runs the narrative.

Before long they will have it back in its cage… and their 2% inflation Elysium will reign for eternity… world without end.

Yet now we are warned the tiger is poised to break loose — again?

That the gates of Elysium — presently ajar — will once again bang shut?

I Hate to Tell You This, But…

Thus Bloomberg’s Simon White asks us to sit down… takes a deep gulp… and warns:

It might look like it’s been defeated, but U.S. inflation is poised to begin accelerating again soon. Stocks and bonds are unpriced for this outcome.

Kind heaven, no. More:

Markets are most sensitive at economic turning points. That’s because they have a tendency to linearly extrapolate trends. But when the data unexpectedly turns, the market is wrong-footed and has to quickly readjust.

We may not see it in July’s U.S. inflation data… but we are on the cusp of one of these turning points. Markets are linearly extrapolating the disinflation trend and are not priced for an inflation revival.

Inflation Isn’t a Linear Process

Jim Rickards often wags his finger at market analysts who linearly extrapolate existing trends.

Market analysts — that is — who believe that the absence of rain for the past three days indicates the absence of rain on the fourth day.

Have another guess says Jim, especially when it concerns inflation:

It’s a nonlinear system… Inflation is not a linear phenomenon but a nonlinear phenomenon that can spiral out of control before you can do anything about it.

Just so. Yet what sinister and dollar-devouring force would turn inflation loose again?

You will have your answer shortly. Let the abovesaid White first hazard an accounting for the present disinflation…

Was It the Fed That Curbed Inflation?

Simon says:

We have to understand the reasons why inflation slowed in the first place. Surprisingly, the Fed has had little direct impact on declining price growth since its tightening cycle began last year…

Instead, outside of the idiosyncrasy of used cars, most of the net fall in the headline and core inflation rate has been driven by commodity prices, and by global disinflationary pressures, principally from China.

To repeat and emphasize:

This general price-falling is the child of declining commodity prices and disinflationary squeezes — principally from China — as Simon says.

So much for the past, so much for the present.

What of the future? Why will inflation go romping again?

Inflation’s Revenge

Why inflation?

The answer is that one of these two disinflationary forces is turning its colors and changing sides.

Previously a disinflationary agent… it will henceforth be an inflationary agent.

Can you guess which one? Is it an increase in commodity prices — or a Chinese inflationary resurgence?

Mr. White gives the answer:

After a year of falling, commodities have started to climb, especially oil. It is benefiting from a number of tailwinds, foremost among them buoyant liquidity conditions. Global real M1 growth is one of the simplest measures of liquidity and it continues to rise; oil and other commodities should do likewise.

That is, the increase of commodity prices will rekindle the inflationary flames.

Commodity prices will account for the inflation that will “blindside” markets — in Mr. White’s telling at least.

The Contra Forecast

Once again Simon says:

Treasuries look prone to falling again once it becomes apparent inflation is not slain, merely dormant. Stocks too, as the rally continues to be driven by the highest-duration sectors and stocks.

It’s a delicate balancing act as excess liquidity continues to be supportive of risk assets for now. But once the inflation data is showing clear signs of rising, it will already be too late to get ahead of the sell-off.

Is there juice within Mr. White’s contrarian interpretation?

As with all crystal-gazing, our answer is the same:

We do not know.

We have munched crow far too often on far too many botched forecasts.

And we lack all appetite for an additional dose.

Yet we incline toward the commodity-pushed reinflationary theory. We believe there is justice in it.

The Inflationary Case, Reinforced

Some $67 near June’s end, one barrel of West Texas Intermediate fetches $82 and change today.

Handsome!

Global eating costs are likewise on the jump.

The United Nations operates a contraption named the FAO Food Price Index.

This thing tracks monthly alterations in the prices of several internationally traded food commodities.

This index posted a 1.3% July increase — its first increase since April.

One swallow does not a summer make, as the phrase runs. And one posting does not a trend make.

Yet the Ukrainian grain deal, so-called, is ended. India, meantime, has choked off portions of its rice exports.

Drought conditions in certain world parts have also resulted in lean harvests.

There you have a choice recipe for inflation in the form of food.

“This is the new normal now,” affirms Rabobank’s commodities crackerjack Dennis Voznesenski, “with more volatility and unpredictability, whether that’s in commodity prices or food prices.”

It’s Not Easy Being a Contrarian

Inflation, disinflation. Which will prevail?

Today we heard the inflationary case. It is not the consensus case. Yet we ask:

Do you wish to peer around the next bend? Do you wish to steal an unauthorized glimpse of the future?

Then you must range out ahead of the herd. You must venture out upon the thin, spindly branches and risk a fall.

You must turn away from consensus.

It is not easy to do — the pressure to conform is vast and relentless.

Can you do it?

More Evidence

Here he sets down additional evidence before the jury:

Global food prices have begun to rise again too, after many months of falling. This typically leads U.S. CPI by about six months.

Overall, two-thirds of exchange-traded commodities have risen over the last month, while the CRB Industrials index – made up of non-futures traded commodities such as tallow, burlap and rubber – has also lifted convincingly off its lows…

Inflation volatility remains elevated and has started to rise again.

Yet why will inflation’s fresh visit blindside markets?

It is because markets have accepted the theory of linear extrapolation.

They go under the assumption that disinflation will persist — that gradually improving skies implies continued improving skies.

And they have locked in their forecasts.