Overnight, US equities traded in the green, US treasuries sold off, and the dollar paused its decline climbing throughout the session. Closing in on month-end with both the UK and US out on Monday’s trade, expect some noise positioning wise as month-end rebalancing flows wash out. In today’s session Asia stocks have traded mixed with US futures in the red for most of the days trade.
Fed officials continue to spruik transitory price pressures, downplaying inflation concerns. Even as continued signs that this narrative may be false continue to crop up in the real world, with Dick’s Sporting Goods joining the growing list of companies pointing to lasting elevated cost pressures. With input costs rising and demand bouncing back it is reasonable to expect the pass through of price pressures to be relatively sticky.
Break-even inflation rates have declined from recent cycle highs as the market, for now, tentatively buys into the Fed’s AIT and transitory messaging. The retreat in break-evens putting a bid under long duration, secular growth, tech exposures, and growth outperforming value in terms of factor exposure. Month to date however cyclicality has clearly outperformed once again, with energy, materials and financials leading from a sector perspective.
We view this as a consolidation of reflationary cyclical exposures, a retracement in a trend that remains intact and continue to position for another leg higher in the reflation trade. Although the caveat here – this may well be the last innings and the easy gains have been made, with the trade ongoing since November.
There are several catalysts on the horizon that could jump start the reflation rotation once again. Personal Consumption Expenditures, a Fed favorite inflation gauge, are due this week, but the bigger catalyst comes in the form of next Fridays US labour market data, which could well spur the next leg higher in US yields which look oversold at present.
We continue to expect higher yields, last month’s miss on the jobs report unlikely to be repeated. Statisticians/forecasters typically cluster around the mean – last month’s big miss sets up for beat this month in conjunction with an ongoing recovery in the labour market. Several states will end the additional $300/week enhanced unemployment benefits early, school reopening’s continue also promoting increased return to work. Hyatt Hotels says they have 3500 positions open and are having “significant issues getting people back to work”, with their CEO highlighting that in states who suspended the enhanced unemployment checks, they have seen an increase in the number of applicants.
With yields potentially set the break higher and curves steepening, with further economic strength filtering through as the labour market recovers, the reflation trade should have room to run, supporting value/cyclicality/economic sensitivity/reflation orientated sub sectors of risk assets. In tandem exerting pressure on long duration exposures. Volatility has also retraced significantly, with the VIX collapsing 37.08% in the last 10 days, indicating that risk asset buoyancy and the cyclical rotation likely has further to run as positioning is grossed up with both volatility and the dollar declining.
Looking further ahead though, investors should have an impending pivot from the Fed on their radars, potentially following in the footsteps from recent more hawkish signals from the BoC and RBNZ. The Jackson Hole meet in August could well serve as a signalling forum with the potential for the Fed to flag an impending policy shift, with pressure growing to withdraw accommodation as the economy recovers and inflation pressures gather steam. As focus shifts to the impact of higher inflation and scaling back QE a different market regime may ensue, with rising inflation and taper talk becoming a catalyst for increased volatility.
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