Fundamental and technical indicators point squarely to transitory inflation

there’s a lot of talk about price inflation because of base effects from a year ago. Other indicators, however, are being cited by some as warning signs of potentially rising price inflation. For example, supply chain bottlenecks and labor shortages are putting existing labor prices under upward pressure.

So over the next few months, the question of whether consumer price inflation is “transitory” will be answered.

To deduce an idea of whether the inflation will prove to be transitory we can look at the price pattern of commodities and apply the Wave Principle.

Since it’s low in 2020, commodities have clearly advanced in a classic Elliott Wave pattern, as shown in the chart below.

Using a Wave-Trend* indicator, we can see a large wave 3 followed by 4. With wave 5, although prices made a new high above the top of wave 3, the wave 5 advance is smaller when compared to the wave 3 advance.

Now, with most market participants, wave A is characterized as a correction in a still-active bull market.

Next, wave B prices have reversed higher, which may seem like a resumption of the bull.

However, those familiar with classical technical analysis should spot the potential set-up for an upcoming peak as the right shoulder of a head and shoulders reversal pattern.

If this is in fact a small bear rally then expect in wave C prices will move impulsively lower in five waves. A wave C is typically at least as large as wave A and often extends to 1.618 times wave A or beyond.

As a result, this evidence suggests that the recent rise in consumer price inflation may be temporary.

Meanwhile, in terms of actual (i.e., monetary) inflation and deflation, the Federal Reserve said this week that it will begin selling its corporate bond holdings, which it acquired last year under its Secondary Market Corporate Credit Facility (SMCCF). The rate of increase in the Fed’s balance sheet has been slowing (disinflation). Deflation (a shrinking of the balance sheet) seems inevitable.

Jobs & Demand

While the unemployment rate dropped to 5.8% in May, there were still 1.2 unemployed people for every job vacancy, which was approximately the same as in the spring of 2017. Employees with at least a bachelor’s degree face intense competition. The labor force participation rate for that group was 72.5 percent in May, only marginally lower than it was in February 2020, before the pandemic struck. The employment situation points to weak not strong demand.

TIPs

Additionally, the yield on 15+ yrs TIPs still does not point to inflation being anything more than disinflationary or deflationary long-term.

Wave = 5 Day Trimmed Mean (70%) – 35 Day Trimmed Mean (70%)

Trend = Current price – 200 Day Trimmed Mean (70%)

*Wave-Trend = Wave + Trend