The money-printing hand writing is on the wall, says Justice Litle. A severe inflation threat is on the horizon. But the bond market is still pricing in a bout of deflation. And that makes Treasury Inflation Protected Securities (TIPS) an amazing deal right now.

This from Taipan Daily:

The euro is fast approaching an inflection point.

On Jan. 15th – Thursday of this week – the ECB (European Central Bank) will meet to decide how much to cut interest rates. The general consensus is that the cut will be big.

I wonder if the euro will “pull a sterling” and go up instead of down on the news. The chart certainly leaves room for that possibility.

As you can see, the euro’s move higher in December was sharp and swift. The ensuing downdraft has been more of a sideways lurch, creating something of a wedge formation. A sharp move back above $1.35 (and above the 50-day MA) could thus see some real upside follow-through.

While it’s generally true that anything can happen, it feels even more true in forex these days.

“Currencies Trading All Over The Map,” the Washington Post reports. “Over the past several months, global exchange rates have taken some of their wildest swings in years, with a fresh bout of zigzags hitting an array of currencies in both rich and poor countries in the past few weeks.”

Much of this uncertainty is tied to the prospects for U.S. recovery and the $64 trillion inflation versus deflation question. The theme song for the period could be “Should I Stay Or Should I Go” by The Clash: If I go there will be trouble… if I stay it will be double.The good news is currencies historically have a very strong tendency to trend. That means an “all over the map” currency period that began in 2008 could revert into a new stretch of powerful (and profitable) trending behavior in 2009.

And speaking of The Clash (and whether “to stay or go”), the powers that be threw a little more light on the subject of treasuries this week. In a speech to the London School of Economics on Tuesday, Ben Bernanke reminded his audience of the Fed’s willingness to buy long bonds.

“In determining whether to proceed with such purchases,” Bernanke said, “the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Brother, Can You Spare Some Inflation

What does that mean? It means the Fed wants inflation, ladies and gentlemen, and will do what it takes to get it.

A small helping of inflation would do nicely, but they’ll take a godzilla-sized helping too, if need be. Beggars can’t be choosers.

The logic is straightforward here. If deflation continues to grip markets, then credit conditions will clearly need “improving,” which, as Bernanke spelled out in London, would mean the Fed buying up treasuries with freshly printed dollars.

If, on the other hand, private credit markets start to “improve” on their own – without the Fed’s help – that means a flood of TARP cash, currently idle in bank vaults, is trickling its way back to work.

Either way, the end result is more dollars circulating through the system – and a jolt of reflation (maybe a BIG one) to go alongside.

Here’s a TIP

The “all roads lead to inflation scenario” is one reason Bill Gross is so high on TIPS, or Treasury Inflation Protected Securities.

Gross, the manager of the $128.4 billion PIMCO total return fund, managed to outperform 99% of his peers in 2008. He and a few others consider TIPS an amazing deal right now, in large part because the bond markets are still priced for heavy deflation. (TIPS outperform normal bonds in times of inflation, but underperform in periods of deflation.)

This presents another interesting way to think about the short treasuries trade – in the context of a TIP/TLT spread. (TIP is the iShares TIPS ETF; TLT is the 20+ Year Treasury ETF.)

As you can see from the chart, TIP dramatically underperformed relative to TLT all through the second half of 2008. This was due to the deflationary impact of the “great unwind” as credit flows collapsed.

You can also note from the chart that, as of late December, TIP started gaining ground again. Inflation-linked securities have grown more popular in recent weeks, as some look around and see the money-printing handwriting on the wall.

Source: Another Way to Play Inflation? Pssst, Here’s a Tip