Research & Commentary

More Inflation-Deflation Misinterpretation

Inflation talk is back in fashion. The gossips may be late to the party.

Firstly, let’s clear this up. Rising prices of goods and services is not “inflation.” Yes, I know that everyone thinks it is. But they are all wrong (gosh, there’s a bold statement!). I may be accused of being pedantic, but the important point is that, correctly used, inflation refers to an increase in the supply of money and credit in an economy. Deflation refers to the opposite — a decrease in the supply of money and credit. Price movements can be linked to inflation and deflation, but most of the time consumer prices are rising and falling for many different reasons. Nevertheless, we have become so conditioned to referring to rising prices as inflation that it’s ingrained into people’s psyche.

Talk of rising prices is back in vogue, fueled by allegedly surging metals and commodities. “Gold gains as metals rally sparks inflation concerns,” thundered a Reuters headline last week. But frankly, gold has drifted higher over the past two years, while silver and platinum are flat. The same could be said for the CRB index which has just this month rallied all the way back to — hold onto your seat — its March 2009 LOW. Industrial metals have risen a little further but this fits well with R.N. Elliott’s observation from decades ago that sideways moves (read: such as triangles) can generate the same type of changes in investor psychology as can more dramatic changes in price, either up or down. That seems to be the case here.


Nevertheless, as our chart below shows, consumer price expectations have been rising. The chart shows our equally-weighted index of consumer price index (CPI) expectations across the G7 countries. We use 10-year breakeven rates to calculate it — the difference between the yield on a nominal bond and one linked to the CPI. The breakeven rate is a fair reflection of the average annual CPI expectation over the next ten years. Having bottomed in 2016 at 1.04% it has risen since and now hovers around 1.68%. The G7 CPI Expectation index is breaking above its most recent high of February 2017. However, an oscillator of price movement, the Relative Strength Index (RSI), is far below where it was back in February. That constitutes bearish divergence and means that the new high in “inflation” expectations may prove to be ephemeral.

Previous post:

Next post: