The reflation trade has further to run

Investors have piled into assets that stand to gain from a global recovery. And while there may be little evidence of inflation as yet, it will come; the only question is how high it will go.

Inflation or deflation? Investors have spent the last few months piling into assets that stand to gain from a vaccine-enabled global recovery. “Frothing” commodity prices should bring higher inflation, but signs remain scant in official figures, says Albert Edwards of Société Générale. US core consumer price index (CPI) inflation, which strips out volatile food and energy prices, came in at 0% in January compared to a month before. In China, year-on-year core CPI slipped into outright deflation for the first time since 2009. “The global reflation trade may well have got ahead of itself.”

Inflation is coming

“The only way is up” for prices in America, says James Knightley of ING. Figures over the next few months will come in much higher because of base effects – the comparison period a year ago coincides with the first lockdowns, which sent prices plummeting. Add in rising energy and metals prices and inflation in the world’s biggest economy looks poised to “sail well above 3%” this spring. 

Vast fiscal and monetary stimulus should keep the inflationary train chugging: President Joe Biden’s $1.9trn fiscal stimulus plan could be only the prelude to even more lavish infrastructure spending. On the monetary side, the US Federal Reserve continues “to buy $120bn of financial assets each month” with printed money.

The UK outlook is equally inflationary, says David Smith in The Sunday Times. The Bank of England’s survey of public inflation attitudes shows the average Briton anticipates inflation of 2.7% in the coming year. Nearly one-fifth are bracing for price hikes of 5% or more. That wouldn’t be unprecedented: UK inflation hit 5.2% in September 2011 during the post-financial crisis recovery phase. There is no question that inflation is heading higher, it is “merely a question of degree”.

Fed up with easy money

It’s true that the US is heading for a burst of inflation, says The Economist, but that is what the Fed is for: for all the brouhaha about it going soft on inflation, its mandate still requires it to hike interest rates if inflation runs too hot for too long. Don’t count on it, says Justin Lahart in The Wall Street Journal. The Fed will regard any post-pandemic inflation bump as temporary, the result of a transient rush of consumers towards restaurants and holiday resorts. It is unlikely to act before there is evidence that consumers’ expectations of higher inflation have become “ingrained”, which won’t happen quickly. “The economy could run hot for a while before anybody is worried enough to reach for the thermostat”. 

There are good reasons to think the Fed will be slow to react, says Eoin Treacy of Fullertreacymoney.com. More than 17% of all US companies are “categorised as zombies”: companies that rely on cheap finance to stay afloat. Interest-rate hikes would cause mass bankruptcies, so “there is just no way the Federal Reserve” can tighten monetary policy when push comes to shove. That means that the dollar is heading lower and global markets beyond America are poised to outperform. The reflation trade has much further to run. 

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