Stocks, bond yields and the dollar are all falling, yield curves are flattening and sterling is marching higher. The “reflation” trades of 2016 that were supposed to mark a turning point in global markets are fading.
The question for investors is whether this is the playbook for the rest of the year, or whether the trends of 2016 will resume in the second half of the year.
What is clear is that much of the conviction with which investors went into 2017 has been lost. This week, Goldman Sachs ditched its long-standing bullish call on the dollar, and Deutsche Bank did likewise with their gloomy sterling outlook. Following the developed world’s two most seismic events last year — the US presidential election and Britain’s vote to leave the EU— investors around the world had positioned for a broad-based reflation trade.
Donald Trump’s surprise election victory was supposed to unleash a wave of tax cuts, banking deregulation and fiscal largesse that would lift US— and global— growth. Meanwhile, sterling’s 20% plunge after the Brexit vote was supposed to pave the way for a surge in UK equities and inflation. This, indeed, is how it played out as 2017 got underway.
The Federal Reserve raised interest rates twice, the dollar reached a 14-year peak, Wall Street hit record highs, and government bond yield curves around the world steepened to the benefit of banks and financial stocks.
But it is now unravelling, in large part due to a clear slowdown in US growth and signs that global inflation is levelling off. Flatter yield curves where short- and long-term bond yields are close to each other suggest economic uncertainty.
“(They) are definitely not corroborating a Trump reflation scenario. Some of the survey data is strong and has hit new multi-year highs, but the real data has been tepid,” said Jonathan Tepper, co-founder of Variant Perception Research. Citi’s economic surprises indexes for most of the world’s major economies have been heading south for the past month. The US index has suddenly tumbled to lows not seen since November and is below all its peers apart from Japan’s. And inflation expectations are showing signs of peaking too.
Estimates of first-quarter US growth have been slashed in recent weeks, with the Atlanta Fed’s closely-watched GDPNow model pointing to just 0.5% compared with around 2.5% less than two months ago. US Treasury Secretary Steven Mnuchin said the Trump administration’s timetable for tax reform is set to falter following setbacks in negotiations with Congress over healthcare.
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