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Reflation Rotation is one of our Q3 Macro Themes at Research Edge.

The investment theme’s submission was simple: until the end of Q3, the US would report DEFLATIONARY Consumer and Producer price reports; and as we moved into September, we’d see the beginnings of deflation rotating towards inflation. Remember, everything that matters in our macro models occurs on the margin.

One of the main drivers of our call was the Leverage Cycle’s peak inflation report that was reported in August of 2008 at +5.3%. Since that CPI report is issued in mid-September (today), we felt that the US Dollar DOWN, Everything Priced in Dollars UP trend could continue. Today, the Buck is Burning to new YTD lows, and the US stock market is hitting new YTD highs. Check. Check…

Now it’s Game Time. Every consensus Wall Street “economist” and/or “strategist” is going to come out parroting Bernanke’s view that we have a “deflation” problem and not an inflation one. That’s what these guys do – they react to yesterday’s news and serve us with nothing useful but an accurate representation of their own revisionist history.

Why is it Game Time? Look at the 3 charts that Andrew Barber and I have outlined below:

  1. Top Chart: at +0.4% m/m, this chart shows the 4th consecutive month where the sequential rate of change in the CPI was UP
  2. Middle Chart: at -1.5% y/y (August 2009), this chart shows you that last month (July 2009) was the low for deflation (-2.1%)
  3. Bottom Chart: shows you 60 years of economic history that contextualizes the July 2009 Deflation low that’s now in the rear-view mirror

Game time occurs when we no longer have to worry about Duration Mismatch. As of the CPI report confirming our DEFLATION bottom at 830AM EST, this is it. This is when consensus morphs into monkey business. This is where you get paid.

If you have been long TIPs, Gold, or anything priced in Burning Bucks, congratulations. That should keep working until the US Federal Reserve acknowledges that this Reflation Rotation is in motion. Bernanke isn’t much of a macro forecaster, so he’ll wait until next month to confirm what I am showing here with red and green arrows in the middle chart. The green arrow confirms economic history (DEFLATION). Meanwhile the red arrow is a proactive prediction as to where reported inflation is headed next, UP.

To Summarize:

IF we are right with this proactive inflation prediction, and …

IF Bernanke is right in his asserting that the recession is “very likely” over…

THEN growth and inflation expectations will continue to signal that the Fed should raise rates from ZERO in the coming months.

KM

Keith R. McCullough
Chief Executive Officer

Game Time: Reflation Rotation...  - a3

Game Time: Reflation Rotation...  - a4