Here's Why the Global Reflation Trade Might Be Over
The softening in China's inflation momentum suggests the best days of the global reflation rally might be behind us.
China has been the central growth driver for the world economy, even though the U.S. became the "flag-bearer of the reflation trade" in the fourth quarter, UBS AG strategists Bhanu Baweja and Manik Narain said. "To a degree, political change in the U.S. stole China's reflationary thunder," they wrote in a note to clients, as real rates and inflation expectations led a global rise in yields.
Those forces in the U.S. soon lost steam. And now the Chinese impetus is fading too as the policy priority there shifts to containing leverage. "The growth impulse from China isn't likely to collapse, but we may have seen the best of it," the strategists wrote.
Data released Wednesday showed China's producer price index last month rose 7.6 percent compared with 7.8 percent in February. Consumer price inflation was 0.9 percent in March, above 0.8 percent in February but well below the 1.7 percent averaged for the first two months of the year, which is a better comparison as it irons out shifts in the timing of Chinese New Year, said Julian Evans-Pritchard, China economist at Capital Economics.
He expects producer price inflation to fall back further as base effects become less favorable and tighter policies lead to a cooling of economic activity, while consumer prices will stay below 2 percent: "The upshot is that those anticipating a further reflation in China are likely to be disappointed."
Baweja and Narain said there are few convincing signs that the U.S. or Europe are ready to take the reflation baton from China. Investment, production and capacity utilization in these regions need to pick up for reflation to bring improved cash flows to global companies, they said.
"If the healing is limited to the labor market and housing, that home-made brand reflation, we may only get more hawkish central banks without the global growth impulse; an unhelpful mutation of the reflation trade," Baweja and Narain said. They recommend paring down some cyclical exposure.