The Reflation Trade
An increase in inflation has been much anticipated, but slow to arrive. Following the November election, the so-called “reflation trade” sparked a sell-off in bonds, driving the 10-year to a yield as high as 2.6%.1 There were smiles all around (or mostly all around) at the Fed, as Yellen & Co. vowed to move towards a normalization of interest rate levels.
That was in the long-ago month of December. More recently, the 10-year was sporting a yield of 2.16%,2 economic data was soft, and price levels were declining again, based, in part, on a drop in energy prices. The Consumer Price Index (CPI) actually fell in May, bringing the increase for the trailing 12-months to 1.9%, below the Fed’s 2% target.3 Speculation moved quickly to the question of whether or not the nascent reflation trade had expired. We’re not so sure. The fact is that the course of rising inflation, like that of true love, was never going to be a smooth one, and the energy overlay has added more noise to the signal.
There are lots of reasons why inflation should keep ticking up over the intermediate term. The economy is still heading in the direction of full employment (something of a moving target), which has historically led to higher wages. Higher wages, in turn, are often a major contributor to inflation. The cost of some items continued to climb. Food, for example, was up 0.2% in May (2.4% on an annual basis), as was shelter.3
Looming over much of this is the situation in Washington, where uncertainty has reigned of late. Just looking at the headlines, it’s getting harder to believe that anything will get done anytime soon. But behind the scenes, tax legislation continues to move forward, and there is general agreement that some kind of spending on infrastructure is doable. Passage of either (or both) would likely bring renewed enthusiasm for the reflation trade.
Inflation is one of those things that’s never a problem until it is. But when rates start to move, they can move quickly. Investors would do well to ignore the short term up and downs in the bond market and avoid over-committing to either side of the “will it or won’t it” reflation trade, especially given the outside role of politics. Here, as always, staying sufficiently diversified to account for a wide range of potential outcomes is the best course.
1. Bloomberg, as of 12/15/16.
2. Bloomberg, as of 6/15/17.
3. Bureau of Labor Statistics, as of 5/31/17.
All investments are subject to risk and will fluctuate in value.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
The information and opinions contained herein are for general information use only. IndexIQ does not guarantee their accuracy or completeness, nor does IndexIQ assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice. Past performance is no guarantee of future results.
MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the mutual fund. NYLIFE Distributors LLC is located at 30 Hudson Street Jersey City, New Jersey 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is Member FINRA/SIPC.