A number of commentators have characterized the recent recovery in stock prices as a so-called “reflation trade”. Our Global Investment Strategy service is skeptical of this interpretation.
For one thing, gold – the classic barometer of reflationary trends – continues to tank. Moreover, there is a limit to what central banks can realistically do to reflate the economy: interest rates are already close to zero in most countries and there is little appetite for additional QE. Yes, central banks can undertake more radical measures but this would only happen in the depths of a crisis.
If anything, the pattern over the past few years has been one where central banks have backed off from additional easing measures once risk sentiment has begun to improve. We saw a flavor of this over the last ten days. While the Bank of England struck a decidedly dovish tone, other central banks have turned a bit more hawkish. Most notably, the Fed stressed in last week’s FOMC statement that a December rate hike was still very much in play, despite growing evidence that the turmoil in emerging markets is starting to spill over into U.S. manufacturing performance. The Bank of Japan also dashed hopes that it would expand its QE program, deciding instead to sit on its hands while hoping for growth and inflation to pick up. Following the BoJ’s example, the Reserve Bank of Australia kept rates on hold, disappointing investors who were hoping for a rate cut. Even Mario Draghi, who only two weeks ago surprised the market by suggesting that more QE and a lower deposit rate were in the works, seemed to walk back a bit from his statement by saying further easing was “an open question”.
Tactically, Fed’s hawkish rhetoric is a threat to stocks. Please see the next Insight, (Part II) Doubts About The “Reflation Trade”.