The Inflation Trade – Obama’s New Stimulus Plan & Australia’s Interest Rate Increase

The Inflation Trade – Obama’s New Stimulus Plan & Australia’s Interest Rate Increase

Today we are going to follow the footprints of the hyper-inflation/stagflation trade. By simply understanding the impact of the important news stories and avoiding the noise of the traditional media outlets, tracking our quarry will be comparatively easy.

Footprint number one: Alcoa has a much better than expected earnings number. However, the meaningful takeaway here is not that a 33.8% decline y0y was better than analysts thought. The gem in this story is that Alcoa beat expectations because of rising prices. Revenues beat expectations because the price of the commodity is rising. We call this little occurrence INFLATION.

Footprint number two:The administration recognizes the economic recovery is in trouble and is preparing another stimulus package. So, we have rising commodity prices and no economic recovery. This combination is called STAGFLATION

Footprint number three: The commodity based economy of Australia heats up and its central bank raises rates. This morsel of a development will have a meaningful impact on the value of the U.S.$ going forward. The Australian announcement clearly strengthens our case for higher commodity prices and in turn inflation, but the real important consequence of the move will be its influence on the carry trade. The money of choice for the carry traders of the world is now the U.S.$.In years past the Japanese Yen was the whipping boy of the money carry trade as traders sold Yen and bought U.S. treasuries or other assets to assistance from the spread in interest rates. Now, with interest rates held down by the Fed, carry traders can sell U.S. dollars and invest in, for example, Australian government debt and profit on the interest rate spread. This trade also benefits as the Aussi $ goes up in value versus the U.S.$. As you can see, this behavior begins to satisfy on itself. The more U.S.$ sold and Aussi bonds bought with Aussi $s the faster the value of one money goes down while the other goes up adding to the profits of the trade. The consequence is a progressively weakening U.S.$ leading to a nasty little thing called HYPER-INFLATION.

Why don’t the powers that be do something to prevent the tsunami of U.S.$ selling you ask? Well, their hands are tied. With commercial real estateteetering on the brink, an increase in interest rates is impossible. You can forget all the verbal attempts the Fed and Treasury secretary make to sustain the greenback.

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