DIY Investor Magazine
/
March 2017
44
Jenna Barnard
Co-head Strategic Fixed Income, Henderson Global Investors
REFLATION FOR NOW, BUT HOW LONG WILL IT LAST?
There is a strong consensus in financial markets these
days. Post the election of Donald Trump headlines such
as ‘regime change’ and ‘the Trump reflation trade’ have
dominated the financial media as investors happily
embraced the ‘reflation’ trend and started to put their
money to work based on the view that growth and
inflation are going to rise. This has favoured equities
over bonds..
However, the catalyst for the rise in bond yields pre-
dates the US elections; since mid-2016 there have
been signs that growth was picking up in the major
economies. Economic surprise indices such as the
G10 Citigroup Economic Surprise Index, show that
economies were experiencing a cyclical uplift prior to
Trump’s election, and Purchasing Managers’ Indices
(PMIs) were indicating a concerted uptick in global
activity.
This uptick occurred in response to a number of factors,
including a loosening of monetary policy in China about
a year earlier, sparking a rally in commodities. Thus,
the rotation seen in equities from defensives to cyclicals
and banks, the consensus move on being long the US
dollar and rising bond yields were already in progress.
Trump’s election simply amplified it — a ‘Trump bump’ if
you like (see chart 1).
Chart 1: Major economies were experiencing a
cyclical uplift pre-Trump
REFLATION FOR NOW, BUT HOW LONG WILL IT
LAST?
Headline inflation is on the rise around the globe on the
back of rising commodity prices, while core inflation
(which excludes volatile items such as food and energy)
remains more muted (see chart 2). In the US the tick
up in activity and expectations of expansionary policies
have helped the trend, while in the UK the commodity
uptick has been exacerbated by a weakening sterling
following the Brexit vote. Headline inflation trends are
similarly on the way up in Europe and Japan.
CHART 2: DIFFERENTIATING CORE FROM
HEADLINE INFLATION
Source: Bloomberg, G10 Citi Economic Surprise Index,
as at 14 February 2017
Source: Bloomberg, monthly data, as at 31 January
2017
Given the current inflation expectations, consensus
among market participants now appears to be for a rise
in 10 year US Treasury bond yields to 3%, which would
represent a further significant sell-off (lower prices) in
bonds. Additionally, data shows that short positions in
US government bond futures have reached extreme
levels compared to history.
A cyclical uptick and not a structural trend
We believe the current uptick to be cyclical in nature,
which should not be confused with the long term
structural issues that we have talked about for so long
— weak productivity, demographics and digitalisation
to name but a few — that ultimately lead to lower growth
and subdued inflation.
