Wednesday's Market Minute: Is The Reflation Trade For Real?

Between both monetary and fiscal policy, too much stimulus in the economy is now creating concerns that some sectors of the economy and market are overheated, and inflation is on the march higher. The yield on the U.S. 30-year Treasury note rose above 2% yesterday to print the highest level in 12 months. Longer-duration yields have jumped to multi-month highs in recent days in a sign of investors anticipating a stimulus-driven rebound in economic activity and inflation. When 30-year yields exceed 2%, and inflation starts to pick up at the same time, they serve as clear leading indicators of economic growth. However, yields at the short end of the bond market curve remain low, with the Federal Reserve expected to keep rates low for a prolonged time.

Under the hood, the key driver for this reflationary trend is primarily due to an ongoing slide in the real inflation-adjusted Treasury yield, expressed by 5-year TIPS (Treasury Inflation-Protected Securities) which are deeply negative. A mild and temporary runup in inflation won't offset the deeply negative real yields in 5-year TIPS, seeing as how buying such a security assures a negative real yield to the tune of -1.83%, an exceptionally unattractive proposition when considering alternatives like equities. Thanks to several converging regime shifts, including a massive spending program backed by the Biden administration, and monetary policy that will stay accommodative for a very long time, the reflation trend in the economy and asset markets may just be beginning.

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