Global reflation set to lose steam – Danske Bank

According to Chief Analyst, Allan von Mehren at Danske Bank, reflation has been the big theme since November and the driver of most financial markets but they believe some of the engines fuelling reflation are set to lose steam over the next three months.

Key Quotes

“A checklist for reflation included (1) economic acceleration, (2) output gap almost being closed, (3) rising commodity price inflation and (4) accommodative central banks. For the US, we ticked all of the boxes while the case for the euro area was less, as fewer boxes could be ticked off. The ‘Trump factor’ and expectation of fiscal stimulus added to the reflation theme but the fundamental economic factors behind reflation were already in place.”

“The ‘Trump factor’ is now losing some momentum and looking ahead, we expect the main drivers on our checklist to turn around: We see a peak in the economic acceleration soon and the impact of rising commodity prices on inflation is set to decline from here.” 

“Finally, we expect global monetary policy to become less accommodative. We believe the Fed will keep a soft stance but to less of an extent, as the Fed Funds rate is likely to move closer to the ‘neutral rate’. We expect the ECB to stay accommodative as we believe the discussion of rate hikes will dampen when inflation declines again. Still, the market seems to question its willingness to stay accommodative, as inflation expectations have come down again recently. When it comes to China, we project a less accommodative policy, as China is tightening to stem the brewing housing bubble.”

“With reflation set to lose steam, the fuel for the bond bear market is tailing off. In addition, a correction – or a pause - in the equity bull market is normal when the acceleration phase is over. We are still long-term equity bulls though, as we do not expect a sharp economic slowdown.”