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Interim Plan: Disinflation or Liquidity Scare?
In 2023 we began planning for a disinflationary phase, and slowly but surely it arrived in the form of a volatile inflation off/inflation on situation with Trump’s tariffs getting in the mix in 2025, distorting natural disinflationary signals.
The volatility has been seen in longer-term Treasury yields. But lately, with tariff noise diminished and the economy tepidly intact, the bond market seems to be settling into the view of gentle disinflationary Goldilocks, if not something more deflationary virulent. If we are right to anticipate a cool down in inflation signaling, understanding which of those two conditions is in play will be important.
Goldilocks vs. Deflation Scare, Later Stagflation
Goldilocks loves her porridge “just right”. Not too cold and not too hot. In this zone we have moderate inflation and/or moderate cooling of inflation. We are in that zone now. An important signaler of continued moderation or something more excessive will be the 10yr-2yr yield curve (YC).
- The economic recovery produced by the inflationary efforts of the Fed and Trump 1.0 government in 2020 created an inflation-fueled economic recovery and curve flattener.
- Next, angst about the effects of that inflationary operation gathered among the public in 2021-2022.
- Then the inversion extremes of 2023 came about. At that time we noted that it is not the inversion that would bring a recession (as touted loudly in the media), but the subsequent curve steepener, when it un-inverts (goes above zero).
- YC un-inverted in 2024 and still no recession. That is because, referring to the gentle downtrends in the nominal yields (lower panels) the curve has been steepening under disinflationary pressure. Sort of a relief valve. The fiscal inflationary effects of the reelection seeking Biden admin in 2024 kept the economy afloat and the steepener tame.
- Today Trump 2.0 readies its version of debt spending and economic stimulus. This is being promoted against the “interim” disinflationary phase…
…not the Continuum’s major trend, which is now inflationary. For more on that please see yesterday’s public article: A Disinflationary Path to the Next Inflation Problem.
The upshot is that Trump 2.0 is operating to a heavily inflationary agenda, with a dovish Fed on rates and internal bond market operations (monetary), and debt spending, deregulation and tax policy, etc. (fiscal).
It actually fits perfectly with the view of easing yields, gentle disinflationary Goldilocks(ish), and later a whopper of an inflation problem. Perhaps after the 30yr yield taps the limiters (green moving averages) for the first time from the upside rather than its previous decades of doing so from the downside. Let’s use 4% as a general target.
This process could last months before the inflationary macro reasserts the main trend. Now coincidentally, I for one gold bug, am anticipating a multi-month correction in the precious metals complex. What are the main macro enemies of gold and especially gold mining?
- Inflation that is working to support the economy (e.g. late 2020-2024) and…
- Goldilocks, where all seems “just right” on the macro front (e.g. 2012-2019, including a long YC flattening).
It should also be noted that if the YC surges upward under increasing deflationary pressure (i.e. monetary and fiscal inflation policy fail to produce desired economic results), the gold miners would probably get croaked into a massive buying opportunity. Here let’s recall that a deflation scare is the best time to buy the gold mining sector (ref. Q4, 2008, Q1, 2020).
Gold mining fundamentals would scream higher if the whole macro were to fold up its tent and tank. In that case, gold would decline, but much less than cyclical markets. Again, the 2008 & 2020 game plan.
Bottom Line
The slight creep up into the red on the YC chart above hints of a possibility that disinflationary Goldilocks could morph to a deflation scare. That could trigger an unexpected severe correction in many markets.
However, a continued gentle disinflation and YC going sideways or slightly upward or downward could provide a setting where Trump 2.0 oversees a tepid and calmly bullish Goldilocks(ish) environment into the mid-terms (as Bessent is surely trying to engineer).
Scenario #2 would be bullish for stocks and bonds, bearish for gold and silver.
Scenario #1 would be, according to the chicken man…
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