Get set for the next inflation scare
The “reflation trade” is coming under pressure. But politicians’ ongoing fiscal splurge means that inflation will come eventually.

The world’s governments have crossed “the Rubicon of fiscal rectitude to a reach a new land”, says Albert Edwards of Société Générale – “one where their existing monetary profligacy can now be coupled with fiscal debauchery”. There is no “turning back now the sweet fruits of monetary-funded fiscal largesse have been plucked and tasted”. So why are bond yields – the borrowing costs of those governments – falling again?
Reflation trade in reverse
Investors have spent much of this year piling into assets that stand to gain from a broad global recovery. Reopening plus continued fiscal and monetary stimulus is especially good for cyclical shares such as banks, industrial companies and commodity producers. Big technology shares, which did very well in 2020, have underperformed.
But this “reflation trade” is coming under pressure. Soaring US inflation had caused bond yields to rise – expectations of higher future inflation and interest rates cause investors to demand a higher yield as compensation. The yield on the benchmark ten-year US Treasury bond rose from below 1% at the start of the year to nearly 1.75% in March. But it has since retreated, briefly falling below 1.3% last week. That suggests markets see weaker growth ahead.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
The same pattern can be seen in stocks, says William Watts for MarketWatch. The small-cap Russell 2000 index, which contains many cyclical businesses, has fallen for two weeks straight even as the tech-dominated Nasdaq 100 has climbed. Tech stocks proved their resilience in the face of the economic turmoil last year, making them a preferred pick if the economy is slowing.
A mere growth scare
“Fears of runaway inflation” have dominated markets for much of this year, says Watts. But the focus is now on “worries about a rapid slowdown in global economic growth”. The fastest phase of the US recovery is over, while a slowdown in Asia could prove a drag on global growth (see below). Investors are also concerned that the Delta variant will wreak new economic havoc. As “the old aphorism” has it, markets “do not react, they overreact”, says the Financial Times. Bond markets arguably overdid the inflation panic earlier this year. Slightly more hawkish language from the US Federal Reserve has since calmed those nerves. Instead, investors have started overreacting to the slightest hint of slower growth.
Politicians’ ongoing fiscal splurge means that reflation will come eventually, says Edwards. “The problem is the markets have been too early in betting on the reflation trade and are now set up for a huge disappointment.” Not so fast, says Ambrose Evans-Pritchard in The Daily Telegraph. Annual US inflation hit 5.4% last month, the highest reading since August 2008 (see page 10). A $3trn US budget deficit and “a 32% rise in the total M2 money supply” since the pandemic began means we are heading for durably higher inflation. That could force central bankers to “hit the brakes sooner and harder” than expected. Fasten your seatbelt.
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.
Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.
He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.
Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.
-
Lloyds axes foreign currency fees for Club Lloyds customers
Club Lloyds customers will be able to withdraw their money abroad without incurring any extra fees
By Daniel Hilton
-
How to invest during stagflation
Trump’s tariffs look poised to push the global economy into a period of stagflation. We look at how to ensure your investments can survive a global slowdown.
By Dan McEvoy
-
Why are energy bills so expensive in the UK?
Electricity bills in the UK are higher than in any comparable rich country. Some blame the net-zero zealotry of the government for that. What is really to blame for high energy bills?
By Simon Wilson
-
Will Putin invade Europe? Why investors know Russia is a paper tiger
Opinion Markets are right to ignore talk of Putin invading Europe, says Max King.
By Max King
-
Why French far-right leader Marine Le Pen has been banned from running for office
Marine Le Pen, presidential candidate and leader of France's right-wing National Rally party, has been barred from standing by the country's judges.
By Emily Hohler
-
Five years on: what did Covid cost us?
We’re still counting the costs of the global coronavirus pandemic – and governments’ responses. What did we learn?
By Simon Wilson
-
Will Trump force the Fed to lower interest rates?
Opinion Markets are ignoring the risk that Donald Trump forces the central bank into reckless interest rate cuts
By Cris Sholto Heaton
-
London can lure Brexit-fleeing banks back to UK – but the City must move quickly
Opinion Many banks fled to Paris in the wake of Brexit but are now in full-scale retreat. The City should move quickly to lure them back, says Matthew Lynn
By Matthew Lynn
-
Protests erupt in Turkey after the arrest of president Erdogan's rival
Turkey's president has jailed his main political opponent, Ekrem Imamoglu
By Emily Hohler
-
What is the Mar-a-Lago Accord and why is it getting attention from Wall Street?
On Wall Street, there is talk that Trump's tariffs aim to make the world’s leaders come crawling to Mar-a-Lago, his Florida residence
By Alex Rankine