yesterday, we got fresh inflation data from the Fed, so the world wants to know, “Hey USA, do you have inflation?”  

bankCore PCE inflation rose +0.2% lifting the Y/y rate to +1.8% which is the highest level since October 2012. Meanwhile,  St Louis Fed President Bullard spoke today and indicated that fed Funds could rise somewhere in the end of the 1Q 2015.  While Bullard is a non voting member of the Fed, he is also a middle of the road guy on the hawk/dove camps, thus we take his comments as being part of a broader thought process within the moderate Fed members that inflation could be higher than expected.  

Next week we will get fresh jobs data, and the street is calling for around 215K jobs to be added.  If this number comes through, it will be the fifth straight month of >200K+ job gains.

So what where is the smart money positioning for inflation and how does this affect emerging markets?   First, in terms of positioning and sentiment, a quick read of Merrill Lynch’s Fund Manager Survey will tell a tale of inflation expectations by managers being the highest since May 2011.  ML goes on to say that TIPS are outperforming Bonds in the U.S. and that secular concern about zero rates is growing.  

In the 1970s,  when inflation reared a nasty head, the way to play to play asset allocation was to invest in real estate, commodities, value stocks and small cap, and sell growth and bonds.

 If you think inflation is coming now – you have to be concerned about EM.  The carry trade has been back in vogue of late as places like Brazil (EWZ, quote), Turkey (TUR, quote) and South Africa (EZA, quote) with higher rates have been a great place for crossover money to invest.  

We have forgotten about the risks of the fragile five (BZ, TU, IN, Indo, SA) not only because they have proven to be more resilient to negative Fed news (bullish on macro) , but also because they have seen a huge rally in their currencies as Yellen's fed has been even more benign than Bernanke’s Fed.

 Watch the US Dollar as your canary to test the Fed and inflation.  A rising Dollar will tell you inflation is coming and the Fed is concerned or even behind the curve.  A rising Dollar will be uncomfortable to EM at first but doesn’t need to signal death.  A rising Dollar will be a signal to sell bonds and buy deep value in global banks and Japanese stocks.

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