Excerpted from the January 15 edition of Notes From the Rabbit Hole, NFTRH170

From Bloomberg on Friday [13th]: "Stocks fell, trimming a weekly gain, while the euro and commodities slid after reports that several European nations will have credit ratings cut by Standard & Poor's. U.S. Treasuries rose..."

This is the news of one failing major currency benefiting the exchange rate of another, along with the Treasury bonds it denominates. Deflation is not global hot money hysterically running from one intrinsically worthless currency to another any more than the 2005-2008 "death of the US dollar cult" represented hyperinflation.

This is a global race to the bottom, headlined by two major debt-mangled currencies as waning confidence ping pongs from one to the other over years, decades and over the 'continuum' (our trusty chart is again reviewed below because well, there still may be one or two readers out there who have not fully taken in its message, which I have beaten you over the head with over these last three plus years).

You know that I am not shy about highlighting the folly of the manic 'inflation bulls' and their hyperinflation hysteria every time the 'continuum' is threatened by a rise in 30 year yields to the monthly EMA 100 (most recently in spring of 2011, featuring Bill Gross' highly publicized and ill-fated Treasury bond short play), which has neatly framed and contained inflation expectations for decades.

Nor am I shy about highlighting the folly of those getting all wrapped up in deflation and the certainty that it is finally going to happen this time, as those cultists would have us believe. There is inflation and there is deflation, all along the continuum.

The long-term picture of the 30-year Treasury Bond yield is one of a deflationary backdrop as the TYX gently slopes downward (like America's prospects for real productivity) over the decades. Against this downward slope are periodic inflationary impulses, which arise as a result of currency-compromising policy promoted as needed for an economy dependant on monetary inflation rather than productivity.

During the inflationary impulses, the majority gets greedy and hysterical about rising prices just before the whole mess reverses downward (red arrows, generally at the 100 month exponential moving average) and it generally becomes very hard for the Federal Reserve to justify manufacturing more currency by monetizing debt.

Then there are the deflationary impulses. Those would be the unpleasant downward spikes in 'inflation concerns', which could eventually morph into all out fears of a deflationary depression. This would be the hysterical opposite of what is going on at the red arrows.

There is no guarantee about the future, but we can state conclusively that each time a green arrow has appeared it has been an excellent time to cast off the deflationary hoopla and deploy as a contrary investor for an 'inflation up' cycle generally lasting a year or more. Similarly, the red arrows have generally provided excellent opportunities to preserve capital in anticipation of future asset buying opportunities. So now, what do we have going on? If the chart above arrests its decline at the green dotted line, we are likely at the start of a new inflation cycle, which would target - you guessed it - the EMA 100 (red line).

Unfortunately, there are two channels with a newer, less downwardly biased one (dotted lines) targeting a bottom now, and the original EMA 100 and straight green channel line targeting something that would be truly painful in the near term, with asset price destruction potentially visiting markets far and wide. I would still debate whether this would be attended by actual deflation. But that is an argument we would leave for the appropriate time, because the answer would be dependant on the capacity at which policy makers are running the money factory.

We want to know whether the next inflation cycle is beginning now, or will begin after a final and terrifying downward spike in yields. We should have an answer when the current price cluster (yellow shaded area on the chart above) breaks one way or the other.

Flipping the market over from yields to bonds, above is the monthly chart of the 10-year US Treasury Note. A version of this chart was shown on the blog http://is.gd/fK4asB repeatedly last spring as Pimco shorted and inflationary hysterics were peaking.

As I recall, the analysis I derived from the chart (and other events going on at the time) as to short-term market activity was by no means perfect, but the main point was that inflation fears were getting over done precisely at a time when players should have been preparing for a swing to the other end of the spectrum. Lo and behold, what has transpired?

The yellow shaded area was the point in question as the financial media and blogosphere were telling us that this was the big one, the inflationary reckoning. Unfortunately, the 10-year had not relinquished its bullish stance so this simple chart guy went on the alert for a cycle change along the continuum.

Recall that 'deflation' was considered crazy talk as a new austerity movement was being lifted in the US, crude oil was rising into a post '08 crash peak, silver was accelerating toward its blow off top and copper was above $4.20 per pound.

Since the long bond's yield (TYX, top chart) has yielded no decision yet and since the 10-year Note (UST) remains in a bullish stance targeting higher levels, it would be wise for people not to make fun of premier 'd Boy' Robert Prechter just yet. The stock market is coming due for a significant correction (at our long-standing target of SPX 1340 to 1360?).

When a correction finally arrives, the state of long-term US Treasury Bonds will be one of the important components used in defining the nature of what comes next. If the continuum is to remain intact, what comes next will be a whopper of an inflation cycle.

The T Bond structure is among several reasons that NFTRH is moving to a view of an ultimately inflationary 2012, just as we were on guard for a deflationary 2011 per this chart (from last spring), and per the most recent red arrow on the monthly TYX. Yet until a reversal is clearly defined, caution is heavily in play. You see?

NFTRH170 then proceeds to an updated 'Current Outlook' and all the usual sentiment and technical tools in the toolbox used to keep us on the right side of macro markets, along with reviews of gold, silver, gold miners, commodities, stock markets and currencies...