Is the reflation trade over? What stock-market investors need to watch

Cyclically sensitive stock-market sectors led a sharp stock-market rebound Monday, but peaking inflation expectations and a volatile cross-asset reaction to last week’s change in tune by the Federal Reserve has investors wondering if the reflation trade — a bet that assets that are set to benefit from a post-pandemic surge in growth and inflation will outperform their traditionally safer counterparts — has run its course.

But don’t throw in the towel, the analysts said. While a peak in inflation worries makes some sense as supply-chain bottlenecks get worked out and base effects — comparisons with prices depressed a year ago by the pandemic — fall out, price pressures may be due to work lower. But, they argued that with the labor market likely to tighten significantly, investors may not have heard the last word on inflation.

That triggered volatile moves across financial markets, with the U.S. dollar soaring. The dollar took its cue from shorter term Treasury yields, which rose sharply, while ignoring a drop in long-term 10- TMUBMUSD10Y, 1.487% and 30-year TMUBMUSD30Y, 2.108% yields — flattening the so-called yield curve. Debt prices and yields move inversely to each other.The shift in the curve was in keeping with expectations that the Fed’s shift was likely to curtail longer-term inflationary pressures.

It was a case of turnabout on Monday, however, with long-term yields rising. The Russell 2000 bounced 2.2% higher, while the Dow rallied nearly 590 points, or 1.4%. The S&P 500 gained 1.4%, with cyclicals leading the way, while the Nasdaq lagged behind, rising 0.8%. “But taken in context, the central bank remains committed to an accommodative posture. The Fed’s statements sparked an immediate rotation out of the reflation trade in favor of growth and defensive sectors, but we anticipate cyclical leadership to return as investors return their focus to the realities of long-term accommodative policies,” Malik said.

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