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Reflation Trade? What’s That?

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  • Investors sour on the so-called reflation trade in economically sensitive stocks and resume consumption of tech stocks and Treasuries
  • Markets are likely to remain volatile in the absence of any clear economic data on recovery, employment and with the constant guessing game of when the U.S. Federal Reserve will turn hawkish

When the U.S. economy started picking up steam again and with as many as half of all Americans having received at least one vaccine does, there was a view in some investment circles that it was finally time to put on the big boy pants.

Forget about meme stocks and cryptocurrency, experts in valuation and price-to-earnings ratios were once again holding court.

But it appears that their time in the sun was brief, as the so-called reflation trade has started to ebb in influence.

Judging by a slew of cross asset signals and where billions in investment flows are headed, exposure to more “sensible” value stocks and economically more sensitive equities has waned while volatility has returned to both meme stocks and cryptocurrencies, with the Nasdaq 100 outperforming the blue-chip heavy Dow Jones Industrial Average by the most in over seven weeks.

While the S&P 500 remained largely flat and debt gauges of inflation retreated from their most recent highs, suggesting that investors are more concerned about growth than they are about inflation.

That’s not to say that the reflation trade is completely dead.

Investors are just now consuming economic data and taking pause, reverting to familiar themes that served them well during the pandemic, assured that the U.S. Federal Reserve has their backs.

Against this backdrop, some fixed income investors are betting against higher levels of inflation, with government debt and corporate securities still finding no shortage of buyers and feeding into the Fed’s narrative that any inflationary episodes are likely to be fleeting.

Much will depend on the sustained economic data following the U.S. reopening and whether prices are rising quickly enough for the Fed to bring forward considerations of tapering asset purchases, or maintain the status quo.

Until the next Fed meeting at least, and without any unequivocal economic data, markets can expected to continue being volatile, with some investors betting on inflation bringing forward tightening, while others betting on the status quo.

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