This unusual chart (which I invented, and indeed cannot remember how to generate... no future updates to this post -ed.) does not depict the relative performance of each asset. It is simply a portrait of the directional movement of several important assets.
The black line is an exaggerated graph of the 10 year Treasury Yield, which is a decent proxy for the desirability of holding cash. The yield can be viewed as a measure of deflation vs. inflation concerns. When the yield is low, deflation fears are rampant and cash is king. When the yield is rising, the economic situation is normalizing. Assets reflate as risk-taking resumes. As you can see, whenever the yield falls, all the asset prices in tandem move sideways. But they do not fall. This is asset reflation.
The next phase of the cycle will begin when the 10 year Treasury Yield moves through 4%. At this point, we will move from a general reflation of asset prices into an inflationary environment.
The most fascinating thing to take away from this graph is the high degree of correlation between these radically different assets. This has been especially dramatic since August as stocks, commodities and U.S. Government debt have all appreciated simultaneously. We are witnessing a widespread reflation of all assets. This halcyon period confirms that the Federal Reserve has won a tactical victory in the battle against deflation. Whether they can develop a strategy to hold the line against deflation while preparing for the battle against inflation remains to be seen.
Federal Reserve Bank of St. Louis President James Bullard gave an interesting interview today in which he stated the interest rates will not rise until unemployment begins to fall. This is a surprisingly candid remark from a Fed official linking the two sides of their dual mandate to maintain price stability and high employment. There are two interesting points to take away from this comment. 1) The Federal Reserve working firmly in the Jennings Bryan mode and investments decisions should be biased toward inflation and take into account a continually depreciating dollar. 2) The Fed is likely to rely on high unemployment to keep wage inflation down through raising rates as the economic picture brightens.
In short, I see the declining purchasing power of the dollar supporting continued price gains in non-U.S. assets and a sluggish U.S. economy that gradually re-balances as a weak dollar support its exports.
[Incidentally, in the chart, you might notice the high degree of correlation between the price of gasoline and Treasury yields. I suspect the difficulties involved in storing gasoline are contributing to its volatility. As the only perishable asset depicted, it exhibits the highest degree of sensitivity to the short term economic outlook.]
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