馃攳
Could the Reflation Consensus be Wrong? | The Big Conversation | Refinitiv - YouTube
Channel: Real Vision Finance
[5]
[00:00:05] As we come in to 2021, this chart
of US M2 money supply growth is at the very
[9]
heart of an overwhelming consensus which expects
that the combination of a vaccine plus massive
[15]
fiscal and monetary support will result in
a huge rebound in growth and inflation, that
[19]
will continue to drive demand for reflation
trades.
[22]
But where could this consensus be wrong?
[24]
Well, that's The Big Conversation.
[29]
[00:00:32] In twenty five years of being in
financial markets, I've never quite seen an
[35]
overwhelming consensus for a New Year like
the one we're seeing today.
[39]
Pretty much every broker, investment bank,
pretty much every asset manager and hedge
[43]
fund manager is looking at some form of reflation
trade for 2021.
[48]
So what is that reflation trade and what are
people playing?
[51]
Well, we can see from some of the conversations
on the Refinitiv platforms with clients that
[55]
there is an overwhelming consensus for a number
of specific trades.
[58]
Now that one of the core of all of this is
being short, the U.S. dollar, almost everybody
[62]
believes that the dollar will be weaker throughout
2021.
[65]
But what are the other trades that really
play into this same narrative?
[69]
Well, obviously, we expect yields to move
higher or people expect yields to move higher.
[73]
That's very core to this narrative as well.
[76]
And here we can see the US 10 year yield and
there's probably a range that's been building
[80]
off somewhere between one point two, five
and two percent for that 10 year yield.
[84]
Now, when you look at this chart, that would
suggest that we're going to see a level which
[87]
is above where we were pre-Covid.
[89]
So that's a pretty impressive move.
[91]
Remember, when yields move higher, as we've
seen before, in true periods of growth, it
[95]
actually becomes quite tricky for markets
to deal with those higher yields.
[98]
But nonetheless, that is the expectation is
that yields will move that through those levels.
[102]
In the credit space, people are expecting
high yield to outperform investment grade.
[107]
In the equity space, people are expecting
emerging market equities to outperform US
[110]
and developed market equities.
[112]
And that's already been working quite nicely,
and even at the beginning of this year, we've
[115]
seen a nice move down in the ratio of the
S&P versus MSCI emerging markets.
[121]
And following that theme in equities, we've
also seen that small caps are being favored
[126]
over large caps, low quality, over high quality.
[130]
We're obviously seeing people looking at cyclicals
and and value over growth.
[134]
So people are thinking about energy stocks
and financial stocks.
[138]
Some of these stocks which have been beaten
down and looking away from the growth stocks
[142]
that have driven the market particularly through
last year, but actually for most of the last
[145]
10 years.
[146]
And obviously, commodities is very much at
the heart of this narrative, at the heart
[151]
of this reflation thesis.
[154]
As you can see here, this is the Refinitiv
Commodity Index, equal weighted and on this
[157]
I've also mapped the dollar index.
[159]
We talked about the dollar earlier.
[161]
This is the dollar index inverted, so when
the dollar is weaker, on this chart, the lines
[165]
going up, that should see commodities going
higher.
[168]
But it does look like the dollar has been
leading commodities, and we will come on to
[171]
that as a key element later on.
[174]
But when we're talking about reflation, and
this is something that we touched upon in
[177]
the last Big Conversation of 2020, is what
type of reflation are we talking about?
[182]
Are we talking about reflation or inflation
or actually could we see disinflation return?
[187]
And the key here and I talked about the dollar,
is that are we seeing dollar driven reflation
[192]
or are we seeing the sort of reflation that
you normally see with synchronized global
[195]
growth?
[196]
And for that, the best chart to demonstrate
those differences or at least demonstrate
[200]
the importance of the synchronized global
growth is the chart of the ratio of the S&P
[205]
versus MSCI emerging markets against the dollar
index.
[208]
Now, the key area to look at over the last
20 years is the period from around about 2002
[214]
to 2008.
[216]
This is the period where China came fully
into the global market.
[219]
It was a huge consumer of commodities and
that drove demand for commodities and emerging
[225]
markets.
[226]
So what you saw in this environment was synchronized
global growth based on China being led by
[230]
commodities in which emerging market currencies,
the high beta currencies, performed well,
[235]
meaning that the dollar underperformed, but
it was synchronized growth that was leading
[239]
the charge.
[241]
We saw a little bit of this in 2016, 17 and
18 as well.
[245]
Today, however, what we're seeing is very
much a dollar led drive.
[248]
i.e a weaker dollar is driving commodity prices
higher and emerging markets higher.
[253]
But is that as sustainable as one where true
global synchronized growth is in the driving
[259]
seat?
[260]
And that's something which I think is going
to really inform whether this consensus trade
[264]
has become a little bit maybe ahead of itself
in terms of where we are today.
[268]
Because remember, when we look at this next
chart, this is the US.
[271]
CPI it's a chart that we showed before.
[274]
This chart shows that when you have recessions,
inflation is normally on a downward trajectory.
[279]
It might be disinflationary rather than deflationary,
but into an out of or at least in the middle
[284]
of an out of every major recession we have
seen CPI in the US falling since the 1970s.
[290]
And if anything, globally, we're probably
going to see a double dip type of recession.
[294]
Here in the UK, we've just got into a lockdown,
which is not quite as ferocious as the one
[299]
we saw in March, but it's not far off.
[301]
Now obviously, we're not as nervous this time
around and people will probably be a little
[305]
bit more lackadaisical with how they deal
with this lockdown, but nonetheless, it's
[309]
a lockdown that's more commensurate with what
we saw in March.
[312]
The difference being that this time in Europe,
we're seeing a synchronized lockdown.
[317]
So the whole of Europe is going into a lockdown
in some shape or form at the same time.
[321]
And that's going to have a negative impact
on GDP.
[324]
Yet here we are at the beginning of 2021 talking
about reflation and the consensus on reflation
[330]
and inflation and that story has actually
been building momentum over the last few weeks.
[335]
So what is it that been driving this reflationary
narrative or inflationary narrative?
[340]
And again, we're going to have to make that
distinction.
[342]
Now, one of the things that we showed the
very beginning was that chart of M2, and I've
[345]
got another chart here, which is the absolute
level of M2.
[348]
Now M2 has exploded high.
[350]
We all know that.
[351]
And this is one of the main driving forces
of people thinking, well, this has inflationary
[354]
potential.
[355]
And it is correct to say that that has inflationary
potential.
[359]
Perhaps the potential is not quite as dramatic
as people think.
[362]
Mike Greene of Logica Capital, argues that
much of this increase in M2 and this is things
[368]
like checking accounts, among other things,
is due to the drawdown by corporates during
[374]
2020 of credit lines for the banks.
[376]
And this is something that Dave Puchowski
of Refinitiv talked about when he was looking
[379]
through the Corona Correction and how people
were drawing down their emergency funds from
[383]
banks.
[384]
So corporates have been drawing down this
credit, putting it into their checking accounts.
[388]
That's part of the build up in M2.
[390]
But in some ways, the way we can think about
that is that the surge in M2 reflects the
[394]
current economic dislocation as much as it
represents future inflation.
[399]
Now, the future inflation potential, but actually
perhaps it's more reflective of the current
[403]
dislocation.
[406]
The second part we've also talked about is
how in this furloughed environment, we've
[410]
seen savings in US and in Europe also explode
higher, something like one point twenty five
[414]
to one point five trillion as people have
been stuck at home, they've been receiving
[418]
their wage support, their income support,
and they've been putting it on deposit in
[421]
checking accounts.
[422]
So, again, that is helped this M2 number build
up and has created this expectation that M2
[428]
having built so rapidly, and this is far more
rapid than we saw in any of the other previous
[433]
recessions, this build up in M2 is now going
to have inflationary implications going forward.
[438]
But what are those corporates are seeing that
because of furlough and wage support, there
[442]
is now no need to use those drawn down lines
and they repay them.
[445]
They give them back to the banks.
[446]
That would be very transitory spike in M2,
which could roll off once markets properly
[452]
start to open up sometime through 2021.
[454]
And one of the other things that Mike talked
about was the bringing forward of demand.
[458]
So what we saw in 2020 was as everybody went
into lockdown, we substituted demand for services
[464]
such as going to restaurants and taking holidays
for demand for finished goods and commodities.
[469]
We stopped going to restaurants.
[470]
We cooked at home.
[471]
We stopped going on holiday, and we built
a garden sheds.
[474]
We built extensions on our houses.
[476]
And this saw an incredible increase in demand
for a lot of finished goods and also for a
[480]
lot of commodities.
[481]
So this was a substitution effect.
[483]
Now, if that demand has been brought forward
now, obviously we are still potentially going
[487]
into another lockdown.
[488]
But the chances are that instead of now building
more garden huts and building another extension,
[493]
we might save that money.
[494]
But that demand was brought forward.
[497]
And also, when you bring demand for it like
that, we push prices up.
[500]
There will eventually be a response from supply
so that demand will be met by a larger amount
[504]
of supply and then that demand might fall
off because logically, as we come out of lockdown,
[509]
we should go back to restaurants and we will
hopefully go on holidays again and we'll spend
[512]
less on commodities and finished goods.
[515]
So perhaps that demand has been brought forward
and also put some pressure on the dollar because
[519]
a lot of these finished goods would have been
coming from overseas places like Korea, Taiwan.
[522]
And so a lot of demand for electronic goods,
commodities might be domestically sourced
[527]
for the US, but also some of these commodities
would have come in from overseas.
[530]
So that was also a driving factor for the
dollar, is that this shift from services to
[535]
finished goods and commodities probably increased
the demand for overseas goods and that would
[539]
have put some pressure on the dollar as well.
[542]
But that's a transitory effect.
[545]
We've also seen as well.
[546]
And this is a key element, which is why inflation
is perhaps a bigger risk for twenty twenty
[550]
one than true reflation, which is true growth.
[553]
Where inflation is brought along for the ride
is that we've seen those lumber prices move
[557]
incredibly high.
[559]
This was a bottleneck.
[560]
It was a bit like the process that we saw
last year process be spiked aggressively in
[565]
the second quarter of 2020, but that was a
supply chain impact.
[569]
The same happened in lumber.
[570]
In fact, lumber fell when people came out
of lock down in Q3 of 2013 is now spiked again.
[576]
But we're seeing these spikes in commodities
across many, many areas, including soft commodities.
[580]
We've seen soybeans, we've seen coal.
[582]
We've seen they've all been moving aggressively
again as well.
[586]
A lot of these are supply chain issues.
[587]
Along with that dollar impact, weak dollar
has been driving commodity prices higher,
[592]
then builds momentum with hedge funds, particularly
fast money positions chasing after these momentum
[596]
trades.
[597]
But is that sustainable demand or is this
simply bottlenecks with a dollar impact?
[603]
So maybe what we've actually been seeing and
one of the reasons why maybe we should be
[605]
a little bit cautious about jumping to aggressively
into this reflationary consensus is that maybe
[611]
that energy surge that is driving a lot of
the expectations, particularly on the fiscal
[615]
side, is going to be very transitory as the
corporates pay that back to the banks.
[620]
We've also seen that demand has probably been
brought forward.
[623]
We've seen this incredible move in the dollar
because the expectation is the Fed is going
[626]
to be the most aggressive, which is helping
drive those reflation trade.
[629]
We've also seen these bottlenecks and supply
chains creating surges in commodity prices.
[634]
Now, when you look at all of that, it looks
like inflation and it looks like reflation
[639]
that maybe these are just reactions to things
like the weaker dollar.
[642]
And something else that we should also bring
into this is that when we look at inflation
[645]
expectations, they've moved, but they haven't
moved maybe as dramatically as we would have
[651]
expected.
[652]
If there is a true reflationary narrative
out there where we look at things like term
[655]
premium on the US 10 year and some premium
is a sort of a premium for inflation that
[659]
you build into the term structure of the bond
market.
[664]
Longer dated bonds should have a higher term
premium, higher inflation expectations.
[667]
So premium went negative a couple of years
ago for the US 10 year.
[671]
It has rallied and is now above where it was
predictable, but it is still in negative territory.
[676]
That's not saying people have massive inflation
expectations for the future.
[679]
One of the other things that we've seen from
the market is that things like the tips, this
[684]
is the inflation protected securities, the
five year the tenure in the US have recently
[687]
touched two percent.
[688]
So people are saying now the market expectation
and expectations are so important in inflation
[692]
have reached two percent highest level in
nearly three years.
[696]
But how they got there, what one of the biggest
drivers of the tips market has been the Federal
[700]
Reserve buying those securities to drive inflation
expectations high.
[705]
Now, why would they be driving inflation expectations
high if the market already thought that inflation
[710]
was going higher?
[711]
It's a bit of a deceit on the part of the
Fed.
[713]
They are needing to drive those because they
want to create the expectation of higher inflation
[718]
in the future.
[719]
But when we look at nominal yields, they have
flatlined.
[721]
Now people will say, well, that's because
of QE.
[723]
But actually, historically, as we've talked
about before, when you do QE, normally yields
[727]
do go higher, yields have been flatlining
or it's really been happening here, as has
[730]
been Federal Reserve pushing its market higher.
[734]
Really yields have fallen.
[735]
That's one of the reasons why gold has been
doing well.
[736]
Remember the inverse relationship between
gold and those real yields.
[740]
So a lot of this is driven by a lot of these
reflation narratives are driven by a weak
[744]
dollar and the effects of the central bank,
the Federal Reserve, in things like the tips
[749]
market.
[750]
And then finally, another chart, which again
suggests that this reflation narrative is
[754]
not actually playing out as clearly as maybe
people think is that German bond yields.
[759]
This is the 10 year yield.
[760]
Now, Germany in Europe is a reflationary play.
[763]
If it was true synchronized global reflation,
you'd expect Europe to do very, very well
[768]
because they export lots of stuff to emerging
markets.
[771]
But here, bond yields have actually been grinding
lower pretty much since the middle of last
[775]
year.
[776]
There's nothing impressive in this in terms
of the reflationary trade now, partly because
[780]
the euro is stronger.
[781]
But if the euro is stronger in a recessionary
environment, there would still be lots of
[785]
exporting going on.
[787]
So it wouldn't matter and you'd still see
yields going higher.
[789]
But what we've got in Europe, the yields grinding
lower.
[792]
So when we look at things like tips, when
we look at term premium, when we look at bond
[795]
yields, that reflation narrative, which is
a narrative among active managers in particular,
[801]
is only partially playing out.
[802]
So in summary, this reflation trade, it's
based on some very real moves in asset prices.
[809]
And given the consensus, it probably should
continue into twenty, twenty one.
[814]
But it doesn't look like it's a reflation
trade based on synchronized growth.
[817]
It looks like a reflation trade based on a
weaker dollar and that we really requires
[821]
the Fed to be the aggressor.
[823]
At the moment, the Fed and the ECB balance
sheets have actually expanded by about the
[826]
same amount over the last 12 months.
[828]
We've seen M2 explode higher, but that explosion,
an end to it, doesn't necessarily mean it's
[833]
going to be moving into the economy with a
velocity that drives up inflation.
[838]
In fact, it may be that it gets repaid if
the worst case scenarios with demand don't
[842]
materialize and those cops feel that they
can pay it back.
[845]
Demand has been brought forward.
[846]
And as we move out of lock down, eventually
in 2020, we'll move back toward services that
[852]
demand to commodities could way that demand
for overseas currencies could weigh and the
[856]
dollar could find itself on a stronger footing
once more.
[859]
So I'm not saying that the reflation narrative
is incorrect, but what I am saying is that
[863]
it is the biggest consensus going into the
new year I've ever seen, and maybe the stories
[869]
behind it are not actually true synchronized
reflation.
[872]
And therefore there is a lot of risk in that
trade if you're going all in at this point
[880]
in time.
[882]
[00:14:43] In the last section, we looked
at this incredible consensus in the narrative
[887]
of reflation in this section, I wanted to
see whether that consensus was much more within
[891]
the narrative, whether it was also among positioning
as well, because if it's not in positioning,
[896]
then maybe the narrative has legs or maybe
that the real market doesn't believe the narrative
[901]
that's mainly been formulated among active
managers, hedge funds, etc..
[905]
Now, what we look at some of the surveys,
things like the Bank of America survey, we
[909]
can see that the classic reflation trades
are the ones that people think will outperform
[915]
in 2021.
[916]
One of the really stands out is emerging market
outperformance, and this is actually increased
[920]
in popularity since November.
[922]
US equities are also popular gold, oil.
[925]
So these are all very much those classic reflation
trades.
[928]
But is that borne out by positioning?
[930]
Is positioning extreme?
[932]
I'm going to look a few of these positions
now.
[934]
Well, firstly, let's look at the dollar and
look at the euro.
[938]
First, euro positioning is extreme, but it's
off the highs.
[941]
And you can see here that over the last 20
or so, 30 years, this position that we've
[947]
seen, the net long position in the euro shorting
the dollar has only recently come off an all
[952]
time high.
[953]
And when these positions have generally pulled
back in the past, we've normally seen that
[958]
the euro has also come under pressure as well.
[961]
So euro positioning is extreme, dollar positioning
is extreme copper futures.
[967]
This is the next speculative positioning in
general.
[969]
Looking at the next speculative positioning,
which is sort of fast money types of people
[973]
and speculative positioning in copper is at
an absolute extreme, marginally off the top
[978]
again, but pretty much as you can see very
much at those high.
[982]
So people really embraced the copper, the
growth narrative, the reflation narrative
[986]
through the copper futures market.
[988]
Now, one of the other areas which been a very
much consensus through 2020 was precious metals,
[993]
particularly gold and silver and gold.
[996]
The positioning there, the long positions,
the speculative positions, they are relatively
[1000]
extreme.
[1001]
But I wouldn't say that this is an incredible
extreme.
[1002]
When you look at this sort of five year chart,
people are long gold, but they're not exceptionally
[1007]
so.
[1008]
But when we look at silver, silver, we can
see is actually quite neutral.
[1011]
And in some ways, if you truly believe in
reflation, then the silver positioning should
[1015]
be much more extreme than gold, because so
not only being a precious metal play is also
[1019]
an industrial metal play.
[1020]
So if you get through reflation, through growth,
through industrial outperformance, then silver
[1025]
should perform very well.
[1026]
We would expect it silver to be much more
aggressively positioned than it currently
[1031]
is.
[1032]
And then when we look at the bond markets
and a lot of people expect that bond markets
[1035]
are where we're going to see this expression
of growth play out, yields are going to go
[1039]
higher one point to five to two percent range
for the US ten year.
[1043]
But actually, when we look at the two, the
five and the 10 year positioning, it's all
[1047]
fairly neutral.
[1048]
So in the bond market, the extremes are not
there.
[1050]
At least they're not in that core part of
the bond market.
[1053]
A lot of people might say, well, that's because
central banks through QE have taken all the
[1056]
volatility out of the market, there is nothing
much to play for in this sort of front and
[1061]
middle part of the curve.
[1063]
So whilst those, the sort of core part of
the bond market, from that 2 year to the 10
[1066]
year space looks relatively neutral, what
about the 30 year space?
[1069]
Because the 30 year space is where if there
is going to be inflation or inflation expectations
[1073]
are truly going to play out, then you'd expect
that to be a net short position in that longer
[1078]
part of the curve where you expect yields
to go higher.
[1080]
And as we can see in this chart, that net
position of long versus short is quite extreme
[1085]
on the short side.
[1086]
It's bounced off the position we saw at the
end of last year, but nonetheless, on a historical
[1091]
basis, this is quite an extreme position for
the 30 year bond future on the short side.
[1096]
So when we take all of that together, it would
suggest that perhaps the narrative is more
[1100]
extreme than positioning.
[1102]
Where we are seeing positions that extreme
they are more to do with the dollar and the
[1106]
commodity complex.
[1107]
So this is the dollar relationship, dollar
reflation rather than true synchronized growth
[1110]
reflation.
[1111]
Core bond market doesn't suggest there's really
that much of a strong view on growth, on reflation
[1118]
until you get at the long end, which is the
inflation sensitive part of the market.
[1122]
But overall, I think that the market is not
necessarily playing this reflation narrative
[1126]
as much as active managers are talking about
it, which again, makes me feel that we're
[1131]
a little bit too early.
[1132]
We've got more lockdown's coming, we've got
a period potentially of a double dip recession,
[1137]
and if we do get the true story of reflation
and even if we get the true story of inflation,
[1142]
that's a story for the second half of 2021,
not for the first half and certainly not for
[1156]
the second quarter.
[1160]
[00:19:11] And you can now get the Big Conversations
from Refinitiv as a flash updates on your
[1169]
Alexa device or Google assistant.
[1170]
If you want to know more about how to download
it to your smart speaker, please go to Refinitiv
[1175]
dot com forward slash flash briefing.
Most Recent Videos:
You can go back to the homepage right here: Homepage