Inflationary Expectations are Rising

Recently the Fed affirmed its worries about rising inflation. If you want to read a good article about this, click here. And today the Producer Price Index (PPI) report for March was released (click for article). How can we examine inflationary expectations without waiting until a CPI, PPI, or GDP deflator report is released? The answer is to examine the ratio of TIP prices (Treasury Inflation-Protected Securities) to nominal bond prices. I have found it useful to use the ratio of 20+ year bonds. In StockCharts.com, the symbols for these are TIP and TLT. So, to examine the ratio, use TIP:TLT. Also, switch to viewing this as a line graph and remove moving averages, etc. but keep the RSI (use 9 periods). The resulting chart is given below (click on the image to enlarge it).

A critical technical formation has appeared with this ratio: a double bottom. Recall from Stikki Stock Charts that a double bottom is a reversal pattern. This price ratio has failed to break below a support level twice, which often (BUT NOT ALWAYS) signals an upward move is forthcoming. According to technical analysis, it is possible to determine a likely upside price target assuming a reversal does occur. To do this, form a neckline connecting prior recent peaks (i.e., resistance). In the present example this is at 1.148. Subtract from this the value of the bottom, which is 1.121, which I will round to 1.12. Then add this difference to the neckline value to arrive at the price target:

TARGET Change = Neckline - Bottom
= 1.148 - 1.12 = 0.028
TARGET VALUE = Neckline + Target Change
= 1.148 + 0.028 = 1.176

So, should this double bottom play out as a reversal, we would expect to see the ration TIP:TLT rise to around 1.176. The graph contains this information with a horizontal line drawn at this value. Notice anything interesting? The price target move us almost exactly to a prior level of support from June of 2006!

How likely is it that we will actually reach 1.176? Note from the RSI that it is not yet overbought, so there is room to move up. It is not far from the overbought reading of 70, however, so there will likely be a short-term downward move before that target would actually be reached. I suggest that you consider a support for the upside rally of a value of 50 for the RSI. As long as the RSI(9) remains at or above 50, don't rule out the possibility of reaching the upside target.