It’s a flatuous world after all.
Who would have thunk it with all the inflation, deflation, disinflation, soft, hard, goldilocks landings palaver. And now apparently a new meme, reflation.
“Economic “reflation” is becoming the next bullish narrative as equity valuation increases continue to outpace earnings gains, at least according to Gold Sachs and Tony Pasquariello.
“If GS is correct on the big calls, the macro backdrop is set to remain friendly: the US economy should continue to grow nicely above trend — picking up speed as the year moves along — with three adjustment rates cuts along the way. to not obscure the moral of that story: the Fed is set to ease policy … into an upswing. while Fedspeak this week had a somewhat hawkish bent, the house view for 2024 remains intact.”
Interest rates, gold, and commodity prices have increased in the past few months. Unsurprisingly, the bullish narrative to support that rise has gained traction. Interestingly, this “reflation” narrative tends to resurface by Wall Street whenever there is a need to explain the surge in commodity prices. Notably, the last time Wall Street focused on the reflation trade was in 2009, as noted by the WSJ:
“The most talked-about investing strategy these days isn’t stuffing money in a mattress, it’s the reflation trade — the bet that the world economy will rebound, driving up interest rates and commodities prices.”
While that “reflation trade” lasted for about two years, it quickly failed as economic growth returned to 2%-ish growth along with inflation and interest rates. As shown, oil and commodity prices have a very high correlation. The critical reason is that higher oil prices reduce economic demand. As consumption falls, so does the demand for commodities in general. Therefore, if commodity prices are to “reflate,” as shown, such will depend on more robust economic activity.
As such. The reflation trade hinges on a global resurgence of economic activity, usually associated with economies recovering from a recessionary period. However, the U.S. never experienced a recession. As discussed in “Deficit Spending,” despite numerous recessionary signals, like the inverted yield curve, manufacturing data, and leading economic indicators, the economy avoided recession due to massive governmental spending. To wit:
“One explanation for this has been the surge in Federal expenditures since the end of 2022 stemming from the Inflation Reduction and CHIPs Acts. The second reason is that GDP was so grossly elevated from the $5 Trillion in previous fiscal policies that the lag effect is taking longer than historical norms to resolve.”
While economists focus on the “reflation trade,” we must answer whether the support for more substantial economic growth exists. This is the sole determining factor in whether the “reflation trade” can continue.
Is Reflation Already Behind Us?
“Interest rates and inflation have ticked up recently, driving investors into gold and commodities. However, the surge in precious metals and commodities is more of a function of speculative exuberance rather than an economic resurgence. As discussed in “Speculative Warnings,”
“In other words, the stock market frenzy to “buy anything that is going up” has spread from just a handful of stocks related to artificial intelligence to gold and digital currencies.” Source