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Reflation trade remains fully intact

The debate about inflation trends in the post-pandemic world is intensifying. The US 10-year break-even inflation rate rose to a fresh seven-year high last week. In January, core inflation in the eurozone reached its highest level in five years. Hopes about pent-up consumer and industrial demand also drove up commodity prices.




Key takeaways:

  • Inflation expectations continue to rise on hopes of further fiscal stimulus and accelerated vaccination roll-outs.

  • We raise our growth and interest-rate forecast, which supports our bullish view on cyclical stocks.

Last week, the price of oil rose to a new 13-month high, and copper rose 80% from last year’s lows, hitting an eight-year high. Federal Reserve Chair Jerome Powell promised again last week to keep interest rates low, as the US is “very far” from a strong labour market, adding that any spike in inflation would be “neither large nor sustained”. Powell also stressed, again, that 2% is no longer the upper limit for inflation. Since the outbreak of the Covid-19 pandemic, various Federal Reserve officials have stated that monetary policy will remain unchanged until late 2022.

What does all this mean for the financial markets?
We continue to believe that inflationary pressures will be transitory and that recessionary after-effects, along with digitalisation and technological advances, will keep structural disinflationary forces alive. At the same time, the likelihood of economic overheating and a temporary inflationary spike within the coming six months has increased. Our economists have raised their GDP forecasts, inflation expectations, and yield forecasts. Equities historically do well when bond yields and inflation rise from low levels due to an acceleration of macroeconomic growth. Cyclicals, in particular, should continue to do well, with financials offering the most upside within the cyclical space when the yield curve further steepens. In the fixed income space, moderate credit risk should continue to do well, while we see further downside over the coming months for the USD versus more cyclical currencies. On the commodity front, we continue to be bullish on oil.

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