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May 30 2019

Disinflation: The Elephant in the Room

Most analysts –and the Fed – don’t understand that inflation cycles are different from business cycles. Understanding this key reality allowed our clients to be properly positioned for the drop in bond yields.

ECRI’s co-founder, Geoffrey H. Moore, who created the original leading index of the business cycle over half a century ago, developed the U.S. Future Inflation Gauge (USFIG) to predict those separate inflation cycle turning points. The USFIG also leads inflation expectations (see chart).

The USFIG turned down early last year, and by summertime it was clear that a fresh inflation cycle downturn was taking hold. That inflation cycle downturn wasn’t obvious to the Fed, which hiked rates in September and December. Despite being forced to pivot hard early this year, Fed Chairman Powell just this month called low inflation “transitory.” Bond markets were also caught flat-footed, with the 10-year treasury yield around 3¼% in October, and again in November, as inflation expectations remained high through last fall.

This is the elephant in the room crushing bond yields. It’s really about the inflation cycle.

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