Expert Commentary

Transitory Inflation (and Deflation)

The devil of “transitory” might be in the detail.

Talk of price inflation is everywhere now. Base effects from a year ago mean that readings of changes in consumer prices have jumped markedly. But some people are pointing to other statistics which might warn of future accelerating price inflation. Delivery times for suppliers are at the highest level since 1974 in the U.S., reflecting bottlenecks in supply chains; and many businesses are finding a shortage of labor, meaning that existing labor costs are exhibiting upward pressure. The big debate over the next three months is going to be whether this upsurge in consumer price inflation is “transitory” or not. Well, we might be able to discern a clue from the Commodity Research Bureau (CRB) index that it will prove to be transitory.

R.N. Elliott was an accountant by profession which is why his empirical study of stock market data produced his very detailed discovery of the Wave Principle. When we apply some of the Wave Principle’s detail to charts, we can sometimes gain an edge.

The chart below shows a clear five-wave advance in the CRB index since its 2020 low. When such a structure appears, the question always remains in the back of the analyst’s mind as to whether wave 3, itself, might be extending, meaning that the advance is only halfway done. Two pieces of evidence suggest otherwise.

Note that under Elliott’s objective rules, wave 3 of an impulse wave can never be the shortest wave, preferably whether calculated on arithmetic or percentage terms. In this case, arithmetically, wave 3 is longer than wave 1.But in percentage terms (as viewed on log scale), it is shorter than wave 1. As such, we’d prefer to see wave 5 end before reaching 250.7.

Note also that wave 4 retraced 0.2308 of wave 3, very close to the Fibonacci ratio of 0.236 which often marks a fourth-wave retracement. If this is correct, then, wave 5 is in operation just now and, when complete, will result in a corrective decline in the price of commodities. If the entire advance from the 2020 low is to be labelled as wave (1) of an even bigger advance, the retracement in price during wave (2) could be quite dramatic. Second-wave declines often make people think that the old bear market is back.

So, this evidence would suggest that perhaps the current surge in consumer price inflation will prove to be transitory. However, if the CRB index does decline in a second wave, that transitory may become a bit more permanent in 2022.

Meanwhile, with regards to actual (i.e., monetary) inflation and deflation, the Federal Reserve announced this week that it will be winding down its support for corporate bonds by starting to sell its holdings, bought last year as part of 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.

Commodities CRB Index- June 2021