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  • The reflation trade has been the dominant theme of market

  • chatter for some weeks now.

  • The idea is that a successful vaccine rollout,

  • pent-up demand, aggressive fiscal stimulus,

  • and a central bank that is willing to let the economy run

  • hot will lead to a jump in growth

  • and rising prices across the economy.

  • We can see how enthusiastically investors have jumped

  • on board with the notion of a reflation trade

  • by looking at the spike in 10-year Treasury yields

  • since the autumn, and in particular,

  • since the beginning of February.

  • Consider also investors' expectations for inflation

  • over the next five years, which are

  • now back to their pre-pandemic levels,

  • judging by the difference between inflation-protected and

  • nominal Treasury yields.

  • In the stock market reflation mania

  • has taken the form of a major rotation between sectors.

  • The big winners of the last decade - expensive,

  • high-growth tech stocks - are suddenly out of favour,

  • while long-shunned, economically sensitive,

  • low-growth value stocks, from banks to materials companies,

  • have surged ahead.

  • Here is a chart of the performance of the Russell 3000

  • Growth and Value Indices.

  • Any time the market coalesces around a single consensus

  • view a bit of scepticism can be useful.

  • Anyone who thinks we are going to exit the Covid crisis

  • on a fundamentally different macroeconomic trajectory

  • than we entered it would do well to look again

  • at those 10-year Treasury yields,

  • but this time over a 30-year period.

  • That recent leap in yields?

  • It barely registers.

  • Are the forces that have driven interest rates down

  • over a period of decades really going

  • to reverse because of the pent-up demand

  • from the pandemic and some government stimulus?

  • Remember also that years of low interest rates

  • have driven asset prices to dizzying highs.

  • A jump in inflation could reverse that process

  • and drive the economy back down towards deflation.

  • This is not just a point about the stock market.

  • The value of US housing stock rose by $2.5tn in the pandemic

  • year of 2020, according to Zillow, to reach $36tn,

  • driven largely by falling mortgage rates.

  • An increase in interest rates could cause housing prices

  • to tumble, creating a massive wealth effect that

  • would stifle consumer spending.

  • High asset prices, like the ones we have now,

  • make growth fragile.

  • Do not take the reflation trade too far.

The reflation trade has been the dominant theme of market

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B2 US FinancialTimes growth treasury market inflation stock market

'Reflation-mania' sweeps the stock market | Charts that Count

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    洪子雯 posted on 2021/03/12
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