Will the reflation trade show further cracks?
Investors bet on higher inflation while faster growth shows signs of stalling
Here are the key questions for markets and investors in the coming week.
Will the reflation trade show further cracks?
Bond markets are voicing the loudest doubts about the so-called reflation trade, or a bet on riskier assets on the back of an improving global economy and higher inflation.
The US yield curve, as measured by the relationship between two-year and 10-year US government bonds, has shrunk to its flattest level since the election of Donald Trump. If investors were worried about faster growth and inflation, the yield curve would be steepening.
Indeed, US, UK and German expectations of inflation for a five-year period starting five years from now have all dropped in recent weeks. Earlier in the year, they had all climbed to multiyear highs.
And the scepticism of the bond market is having repercussions elsewhere. Having recently given up their gains for the year, Japanese equities have extended their drop into negative territory for the year. Nor is it just because of a stronger yen. The relationship between the 10-year and Japan’s share market is very pronounced, as the chart below shows. The 10-year yield touched a new low for the year of 2.28 per cent following the release on Friday of a weak jobs report for March.
With the US government bond market signalling expectations of middling economic activity, it is also prompting investors to pay up for growth potential in the equity market. The standout sector for the first quarter was technology, led by the big guns of Amazon, Apple, Facebook and Microsoft.
Another place to check on the health of the reflation trade is small-cap US companies. They were early — and major — beneficiaries of Mr Trump’s pledge to cut corporate taxes in the US, but have since relinquished some of their gains.
The Russell 2000 index, home to US small-cap companies, has lost nearly 2 per cent so far in April, and last week briefly entered negative territory for the year. Paul Ryan, speaker of the US House of Representatives, did little to help sentiment last week by warning tax cuts take time to get through the sausage factory that is Congress.
Will earnings season spur further gains for Wall Street?
It’s that time again. Quarterly reporting season for corporate America begins next week and, when you look under the hood, there will be plenty to chew on for investors.
Earnings for S&P 500 companies are forecast to grow at an annualised pace of 9.4 per cent for the first quarter, according to analysts, up from a 5.4 per cent in the final three months of 2016. Revenue, or top-line growth, is projected to have risen 6.6 per cent in the quarter, up from a 4 per cent pace in the fourth quarter.
All well and good — until you strip out the energy and finance sectors. “Outside of energy and finance, earnings growth is instead expected to decelerate to 3.2 per cent in 1Q from 4.4 per cent in 4Q,” analysts at Bank of America Merrill Lynch note.
Top-line growth and upbeat guidance from companies may well be sufficient to keep the equity market buoyant into summer as investors await a deal on tax reform and other stimulus measures between the White House and Congress.
A new record for coking coal?
On Friday the price of coking coal surged to $283, a record-breaking jump of 34 per cent as steel mills across Asia scrambled to secure supplies of the commodity. A tropical cyclone has disrupted supplies in Australia, one of the world’s biggest producers of the steelmaking ingredient.
The all-time high for spot prices of $330 was hit in 2011, after another bout of disruption because of extreme weather. Traders are now asking if that level will be tested again. With a key rail system connecting mines in Queensland with ports on the east coast expected to remain shut for about five weeks, it can’t be ruled out.