Reflation trades pummelled as Fed’s shift resets markets

The “reflation trade” that has dominated financial markets since the emergence of coronavirus vaccines last year has been pummelled after the Federal Reserve unexpectedly signalled a shift in its stance on inflation.

Commodity prices have tumbled, while the dollar and long-dated US government bond prices raced higher, after the Fed earlier this week reacted to unexpectedly strong inflation data by moving forward its guidance on when it might start raising interest rates.

The moves mark a major setback for investors who this year have rushed to buy securities that might benefit from faster inflation, betting that the combination of exceptionally easy monetary and fiscal policy and a global economy emerging from its Covid-19 lockdown would cause prices to spike.

But the unexpected central bank pivot has raised doubts about how much inflationary pressure the Fed is really willing to tolerate. The central bank also signalled that it would soon start discussing when it will taper its $120bn-a-month bond purchases.

“If any time the Fed gets a whiff of inflation and they come in and slap it back down, why would any investor worry about long-term inflation being too high?” said Michael Pond, head of global inflation-linked research at Barclays. “The more the Fed is concerned about too high inflation, the less the market should be concerned.” 

Markets steadied on Friday morning, with precious metals rebounding slightly from the previous day’s losses and bond yields little changed.

Krishna Guha, vice-chair of Evercore ISI, said Thursday’s violent moves had come as some investors were forced to liquidate reflation trades when markets moved against them.

Natural resources suffered the biggest hit, with Bloomberg’s commodity price index tumbling 3.6 per cent on Thursday, its biggest one-day drop in more than a year, with WTI oil falling 1.5 per cent. 

So-called US value stocks — often cheaper, out-of-favour companies that are more sensitive to the pace of economic growth — fell another 1.3 per cent on Thursday to extend the initial drop they suffered on Wednesday, the day of the Fed’s announcement. MSCI’s index of global value stocks had already fallen 1.2 per cent on Thursday. 

The Russell 2000 index of smaller US companies declined 1.1 per cent — the biggest reversal in over a month — while the price of a troy ounce of gold slipped to a two-month low of $1,773 on Thursday, before picking up slightly on Friday. 

Other assets have benefited, however. The fading chances that the Federal Reserve will let inflation get out of hand helped trigger a rally in long-term US Treasuries and other securities that benefit from disinflationary pressures, such as highly rated corporate bonds, the US dollar and many big technology stocks. 

The yield on 30-year US Treasuries plunged to its lowest level since February, and was at 2.07 per cent on Friday, down from 2.21 per cent ahead of the Fed meeting. Yields fall when prices rise.

The scale of the shift in the world’s largest bond market is a sign that investors are starting to question the Fed’s commitment to its new more flexible inflation-targeting regime, according to Guha. Since last year, the US central bank has said it will let inflation run above its 2 per cent target to balance out periods of low inflation.

Since Wednesday’s Fed meeting, however, market expectations of inflation extended their recent declines. The 10-year US break-even, a closely-followed gauge of expectations over the next decade, traded at 2.29 per cent on Friday, down from 2.39 per cent.

Despite the post-Fed moves, some investors are keeping the faith with the reflation trade. Mark Dowding, chief investment officer of BlueBay Asset Management, said the Fed’s plans to taper its asset purchases would eventually weigh on bond prices and force yields higher, adding that the central bank had simply reacted to stronger-than-expected inflation data over the past two months rather than making a fundamental change to its policy.

“The average inflation targeting approach remains intact, as does strong economic growth,” he said. “This has been frustrating, but it’s been one of those moments as an investor when we have to stick to our guns.”


Source link


A Brief History of Fiverr’s Out-of-Tune Marketing Campaigns

What do I know about thermodynamics, marketing, and freelancing? I'm just a humble and overweight Noonies2021 nominee for the Critical Thinker of the...

Summer Books 2021: critics’ picks

Roula KhalafFT editorThere are several superb books to recommend to readers this summer, including John Preston’s Fall, the fascinating tale of the rise and...

JPMorgan Chase resumes donations but snubs Republicans who contested election

JPMorgan Chase will resume making political donations but not to candidates who voted against certifying Joe Biden’s election victory, after pausing contributions in...

CD&R set to continue pursuit of UK’s Morrisons, FT says

Article content U.S. private equity firm Clayton, Dubilier & Rice (CD&R) is set to push ahead with its pursuit of British supermarket chain...

How to Use Macro Data Points to Understand SMB Financial Performance

Tech-first SMB lenders are leveraging the power of alternative data to close the finance gap. Alternative data - financial information that comes from...