Reflation is the early phase of an economic upswing, characterized by an increase in economic growth and a pick up in inflation. With global rates near zero, and a record stimulus package, this set the perfect environment for a new economic life cycle.
The most recent US job data was stronger than expected, with 379,000 jobs created in February compared to the survey expectation of 182,000. Recovery in the job market signals for a potential rise in wages, which will translate to higher goods and services prices, known as inflation. As inflation picks up to a certain set level, the Federal Reserve Bank will typically respond by raising interest rates. Currently, the Fed is targeting 2% inflation in the long run.
In a reflation setting, bondholders will typically sell their older bonds with lower yields in the anticipation that the new bonds being issued on the horizon will have higher yields. Such action is referring as a reflation trade as bond prices drop upon selloffs and yields rise higher. This has been the case over the past weeks as the benchmark long-term Treasury yield has risen above 1.6%.
In the equity markets, reflation trades are reflected in the shift from growth stocks toward value stocks. In particular, sectors such as a cyclical, commodity, and bank tend to be reflationary winners. This phenomenon has been reflected in the relative outperformance of the Dow Jones in comparison to the Nasdaq and S&P 500 (US500) over the last one-month period.
In summary, the market is currently undergoing this reflationary phase with investors expecting higher economic growth and inflation forecast. The US CPI data this Wednesday will offer the latest look at price pressure.
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