In "Emerging Markets Lead U.S. Inflation," it was pointed out that emerging market equities (EEM) act as a leading indicator to U.S. inflation by an average of 6.5 months. In 2018, emerging markets peaked in January, and U.S. inflation saw its multi-year high roll over.

In higher inflation environments, capital inflows to emerging markets primarily due to the fact many are commodity producers. When looking at capital flows into EM-nations and real treasury term premia, inflows are partly responsible for driving up interest rates.

Money flows into emerging markets continues to has a strong relationship with Chinese monetary policy.

Treasury Inflation-Protected Securities (TIPS) may be sending the signal that last year's deflationary push in asset prices and commodities aren't over. These bonds are indexed to inflation and backed by the U.S. government as the bond's par value adjusts with the inflation rate.

TIPS generally move with the trajectory with consumer prices (CPI), but instruments like iShares TIPS Bond (TIP) ETF gives a real-time, market-based look at inflation expectations; and it's not stellar.

iShares TIPS Bond ETF (monthly)

TIP price action has traded sideways since the 2012 all-time high that coincided with the sharp rebound in real yields (nominal interest rate minus inflation). The quick breakdown in 2018 was largely due to the rapid rise in real yields, which is something I predicted going back to December 2017.

The inverse correlation with 5-year real yield and TIP is quite apparent and directly affects gold prices. If TIP remains under 110, price action will be consolidating underneath a decade-long former support - now resistance - that will likely play out unless the Federal Reserve reverses their monetary tightening, which is disinflationary by nature.

5-Year Real Yield (purple); TIP (yellow)

The further  breakdown and selling of inflation-protected securities will probabilistically become unavoidable unless the trajectory of both growth and inflation accelerate and inflation, currently 190 bps in the U.S., outpace consumer prices.

If I were to apply the TACVOL process to 5-year real yields, the risk would be to the upside 122 bps/79 bps. This is not to suggest real yields could not fall, but that would be up to how the macro drivers filter throughout the data. In that case, TACVOL would be updated immediately.

What it is suggesting is that real yields are approaching the intermediate range bottom, and the combination of tighter financial conditions/monetary policy and falling consumer prices are not done running its course.

Unless, TIP can gain momentum from current levels, we could see a repeat of 2015.

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