Reflation Reflation Reflation

Reflation on the brain

Equities 10 minutes to read

Summary:  US cash markets were closed overnight for the Presidents Day holiday, but ended last week on a firm footing, with all 3 major indices trading higher on the week. We discuss the ongoing reflation thematic and look ahead to potential pathways should yields continue their march higher.

Despite a quiet week ahead, reflation remains firmly in focus, oil prices are at 13-month highs, and global growth is rebounding as vaccination programmes roll out.

Equities broadly remain supported by combination of factors. The economic recovery is accelerating and becoming more broad based, add in a consistent supportive policy trajectory, and the inflection in the earnings cycle, and we have a trifecta of drivers underpinning an ongoing melt up with markets hitting sequential all-time highs amidst a fiscally fuelled reopening. Business conditions are recovering, focus has shifted to the widespread vaccine rollouts and what lies the other side of the pandemic with earnings corroborating cyclical allocations.

The VIX Index closed below 20 on Friday for the first time in 246 days and the VXN continues to break lower. As volatility breaks down, this provides just 1 more of the many reasons for stocks to rally. With the USD and volatility on the decline asset managers will gross up positioning.

Fed policy remains in a sweet spot and will remain historically accommodative whilst the Fed focus primarily on the full employment side of their mandate. Chair Powell confirmed last week, the labour market is a key determinant for policy and central banks are actively looking for inflation, particularly within the remit of average inflation targeting (AIT) regimes. Given the abundance of labour market slack that is likely to still be in existence as inflationary pressures build, the Fed are set to remain on easy street for a prolonged period.

In conjunction with last week’s US CPI print giving a modest read on inflation, providing leeway for further stimulus and the confirmation from Powell’s speech that the Fed will run the economy hot, this pillar of support for markets remains intact but continues to fuel deep societal imbalances. Wealth inequalities are chasmic, the cratering divides between Main Street and Wall Street are palpable and the increasing wealth transfer to those already asset rich, aided by unconventional monetary policies, is fraying our social fabric.

A recovery in corporate earnings is another pillar of support for the reflation thematic. More than 80% of the 373 S&P 500 companies to report so far have beat expectations and earnings growth is coming in at 6.42% yoy vs. -7.44% in 3Q. As comparisons ease into 1Q and 2Q yoy earnings growth will continue to accelerate to the upside. 4th quarter reports in the US are indicating the earnings cycle has inflected and we are looking ahead to a multi period earnings uptick.

In Australia, the trend is similar, earnings have surprised to the upside so far and more importantly forward outlooks are being upgraded, confirming our aforementioned view of earnings becoming a catalyst for a continued upgrade cycle.

Coming out the other side of the pandemic many resilient companies have adapted in response to the crisis and are now positioned to leverage the inbound and accelerating economic recovery. Balance sheets have been bolstered, cost structures have been optimised and leaned out, and demand is rebounding with vaccines now being rolled out on a large scale and pandemic fatigue setting in.

Finishing last year with a laggard tag, the more cyclically orientated nature of the ASX 200 should support index performance throughout 2021. This could see the index shifting from underperformer to outperformer in the year ahead. Particularly as various commodities rev-up into 2021 with a vaccine rollout, demand bounce back weighed against supply deficits and fiscal spending boost, alongside tailwinds of a weaker USD and higher inflation.

However, the bond market is responding to this reflation theme, and will continue to do so, with the 10yr yield continuing to breakout hitting new cycle highs and yield curves steepening. For now, the prospect of inflation with a commensurate pickup in growth is not a problem for stocks. And is an ideal environment for real economy stocks, cyclicals, and commodities. All preferred overweights.

Yields globally are rising - When does this become a pain point for markets? The problem here is the impact on the equity complex with the current market regime heavily skewed toward liquidity & multiples. In due course inflationary pressures and higher yields brings volatility risk for risk assets. A continued march higher in yields can eventually lead to multiple contraction, hitting speculative portions of the market like bubble stocks that rely on low rates to propel their infinitesimal valuations.

What happens if inflation really surprises, and back end yields rise in a disorderly fashion. If inflation gets hotter than the Fed’s new AIT regime banking on, it could trigger widespread duration selling sending shockwaves through risk assets if yields spike.

However, the Fed’s pain threshold is likely to be low because the nascent economic recovery will be vulnerable. The reaction function of central banks is now very different, with emphasis firmly on the risks of premature policy withdrawal and there is very little escape velocity from current policy settings. As growth recovers, how does the Fed pull the plug especially with another round of stimulus propelling markets further into the stratosphere. Ultimately, if this trend were to derail markets, policy would reach for the accommodation lever once again. The Fed would move to cap long-duration yields, resulting in deeply negative real yields underpinning asset prices once more, but we’re not at that point yet. For now, the Fed’s messaging seems to be to let long-duration yields rise until the level causes market distress, so before curve control higher bond yields and steeper curves are likely.


Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (
- Analysis Disclaimer (
- Notification on Non-Independent Investment Research (

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000

Contact Saxo

Select region


The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.