Rabobank: The Reflation Trade Is Coming Into Question Already
By Michael Every of Rabobank
Up until the final few seasons and absolutely the final couple of episodes, there was universal agreement that ‘Game of Thrones’ had been great. One of the things that had been so great about it was the long, slow-moving tale, rich in nuance, told over many years, and in weekly instalments all of us got to see at the same time. That’s what the entire history of mankind since we first sat around the fire together has been about. In a simple word, broadcasting, as opposed to the narrowcasting box-set-binge atomising experience we have today, which wouldn’t exactly have kept a hunter-gatherer society together. (Or a more complex one, evidently.) Besides the socio-psychological commentary, there is a direct parallel today for markets.
It is not even the end of January 2021 and yet the great global meme for the year –“The Reflation Trade”– might be coming into question already. That’s right: the market may have binge-watched the whole thing in just three weeks.
Of course, the “Reflation Trade” was never related to underlying economic fundamentals. These have been lowflationary/deflationary for decades, as we have explained many times before. The disruption of Covid-19 is widely recognised as having accelerated our underlying labour vs. capital and monopoly/monosophy-power MNCs vs. powerless SMEs dynamics.
Yes, we have official recognition that we need more fiscal policy. Hurrah. But most of that spending is in the rear-view mirror already; and it is merely putting the same, and often *less*, back into the economy than is taken out by state-imposed virus restrictions. In balance-sheet terms, if the private sector net saves an extra 3% of GDP due to a drop of confidence or being told to stay at home, and the government spends an extra 3% of GDP, that isn’t reflationary at all.
(On the virus itself, critics point out the new measures proposed by President Biden –to vaccinate 100m people in 100 days and mandate masks in federal locations and on transport– do not appear different to the 17m people vaccinated in 17 days seen in January, or the ineffective mask mandates in Europe. Meanwhile, Glastonbury 2021 just got cancelled and PM BoJo is refusing to rule out virus restrictions lasting into the summer. “Reflation”.)
What one would need to see is a government fiscal package to push the fiscal deficit even wider *once the recovery kicks in* via capital investment- and labour-friendly projects: in other words, to ‘run hot’ on inflation, like some central banks have pledged. Where do we see that? We have a proposed leap in the US minimum wage – but no guarantee it will pass; nor the multi-trillion Green New Deal or infrastructure spending. Europe has its ‘Rubicon-crossing’ fiscal package, of course, but it is may be a one-off, and again puts in much less than has been taken out already: and Europe is now slipping into deflation not reflation. Even China, which knows from fiscal stimulus, Bloomberg’s “China credit impulse” looks like it has topped out and is now about to head down again. Australia has infrastructure plans for it for once, but not enough surveyors to help build the stuff! And where is the protectionist trade policy to keep state spending (and jobs) at home? Maybe that’s what Yellen meant by saying the US pursing “a rules-based trade system that protects us”- but I don’t think markets see it that way. Or, failing that, the low/middle-income tax cuts?
We made this point in a report last month: wars see a downturn not a boom when they end as fiscal support is rolled back too fast for the private sector to handle. Although if you are a reflationista, President Biden is reported to be considering expanding US troop numbers in Iraq, and Secretary of State Blinken has suggested Georgia should join NATO, provoking Russia, and has backed appointing a Special Envoy to monitor military developments in the Horn of Africa. But is that really the boxset you thought you were binge-watching?
Matching the overall net fiscal reticence, not rhetoric, we also need to consider that central banks are suddenly sounding more upbeat. The ECB (see our take on yesterday’s meeting: “The ship is leaking”), BOJ, CBRT, BOC, BCB, BNM are all now trying to accentuate the positive: even some Fed speakers keep mentioning tapering. Okay, one can see why: let’s build optimism. Yet if the market gets the merest hint this means central banks will tighten or, over time, to not keep loosening, then goodbye asset reflation.
Of course, the economic data are going to push and pull on the “Reflation Trade” narrative as places open and close and base-effects play havoc; and, yes, genuine supply and demand in some key commodities may remain inflationary. But keep asking yourself: have the working class started to get a better deal yet or not (and one that will allow them to literally swallow higher commodity prices rather than them being a form of tax?) When they do, let’s talk reflation. Until then, let’s not. Indicatively, the biggest net income boost the UK has proposed so far is to float GBP500 for anyone who tests positive for Covid-19, because fear of lost income due to quarantine means few are coming forward to be tested: but that is one week’s average pay when you have to stay at home and not work for nearly two. (But, knowing the Brits well, watch the teens and tweens who deliberately try to infect themselves to get a free 500 in “beer tokens”.)
And on tokens, one place one might want to look to see if we have binge-watched a 52-week 2021 reflation trade in just 3 is 10-year US yields, now around 1.11%, but not pushing up. The 10-year US breakeven is also at 2.17%, but that is looking like it *might* have topped at around the levels we saw back in 2018 before it last began to shift steadily lower. Moreover, Bitcoin has been smashed to bits and may close more than 14% down this week. Yes, one can make the argument that cryptos always bring a knife to a gunfight against the kind of government that can reflate fiscally (and even generic Big Tech was in the crosshairs of the EU yesterday, calling to the Biden administration to help regulate it together); but there may be more of a message in there than one thinks. Gold has been sending the same signal since late December too: who knew that a hoary old asset like that was also into binge-watching boxsets?
So Reflation Trade or Reflation Fade? Bitcoin or Bingecoin? That’s what makes a market. It’s about the only market we have left, some might say.
Fri, 01/22/2021 – 09:05