So....About That "Reflation Trade"

The original chart was of TIPS vs 7-10 Year Treasuries, except inverted. So rather than a failed breakout from all-time highs, it was actually a failed breakdown from all-time lows.

The reason we look at this chart is to measure the Bond market's inflation expectations. If the ratio is rising, Treasury Inflation-Protected Securities are outperforming Treasuries of the same duration. When it's falling, as it has for 2.5 years, then they're underperforming.

If TIPS are outperforming, then inflation expectations are rising. If they're underperforming, then inflation expectations are falling.

A decade-long support level would be a very logical place for a long-term reversal to begin, but there's a hell of a lot of work to be done still. Three months of upside and everyone's ready to call for a permanent rotation into Cyclical Stocks, broad-based Commodity exposure, etc.

Click on the chart to enlarge view.

And TIPS/IEF is not the only ratio at a critical level. Several other intermarket relationships we look at to track Interest Rates and inflation expectations are also at critical levels.

In the Commodity market, we've got Copper/Gold briefly undercutting its lows from the late 1980s, as well as the 2009 lows, and reversing higher as momentum diverges positively. Again, a lot of work to be done, but this could be the start of a larger move.

In the Currency market, we look to the Australian Dollar/Japanese Yen. This pair didn't quite make it to its 2009 lows, but it did undercut decade-long support at 71.50 before reclaiming it earlier this month. Again, a big step in the right direction.

In the Equity market we've got a lot of different measures we can use, but one of the most basic is the Regional Banks/REITs ratio. After undercutting a 5 or 6-year support level, it quickly reversed and has been grinding its way higher ever since.

Meanwhile, the Financials vs S&P 500 ratio found support at its 2009 lows and has begun to mean revert higher as well.

My broader point in going through this exercise is this: what we have in all of these ratios are "potential" inflection points. Three months of positive price action does not reverse a massive downtrend in Rates/Inflation Expectations.

Long-term trend reversals have to start somewhere and this would be a "logical" level for many of these charts to begin reversing course, but it's likely to be a messy process that takes many quarters/years before we see them all trending higher in tandem. 

That doesn't mean you can't make money trading these short-term moves. It all comes back to knowing your timeframe and objectives as a market participant.

If you've been trading the bounce in these ratios (or correlated assets) and have made money over the last few months, that's great. But if you've got a multi-quarter, multi-year timeframe, then putting this move into its longer-term context is extremely important.

The mean reversion in these charts will slow eventually, and when it does, we want to be taking note of how they correct (in terms of price and time). That will provide a lot of insight into whether the recent move was simply a counter-trend one or the start of something more.

Nobody knows if this is "the bottom", so we just have to take it one data point at a time and adjust as the market develops. Nevertheless, these are the intermarket ratios we want to be watching to keep our pulse on Interest Rates in the US and around the globe.

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Thanks for reading and please let us know if you have any questions!

Allstarcharts Team