Reflation Trade Heating Up

In this first trading week of 2021, a new investment theme appears to be emerging. That theme can be summed up in a single word – reflation.

A resurgence of inflation is being priced into asset classes across the board. Stocks are rallying to new records. Shares of Tesla and alternative energy companies are going to the moon. Marijuana stocks are suddenly back in vogue. Bitcoin is going bonkers.

Crude oil, copper, and other commodities also started to break out this week. But precious metals markets pulled back sharply this morning on the heels of a bad jobs report., meaning these markets require more time to work their way back up to last year’s highs.

President-elect Joe Biden is vowing to make good on President Donald Trump’s promise of $2,000 stimulus checks to most Americans. Biden also intends to push a $4 trillion “Build Back Better” agenda centered on “green” infrastructure programs.

Senate Republicans will have less leverage to block Biden’s spending ambitions. On Tuesday, Democrats picked up two Senate seats in Georgia to deny Republicans a majority in the Upper Chamber.  

The prospect of a Democrat-controlled government is being greeted with surprising enthusiasm by investors. The prevailing thinking seems to be that more government spending and more cash injections into the economy mean higher asset prices.

But the bond market is starting to warn of potential risks looming.

Bond yields broke higher this week. The 10-year Treasury yield climbed above 1% while the 30-year long bond exceeded 1.8%.  

These yields are still quite low, historically speaking. The problem is that even relatively mild increases in current rates cause bonds previously issued at lower rates to lose value.

Not only do those bonds not pay enough interest to keep pace with inflation. But holders of them also stand to suffer capital losses to boot.

The Federal Reserve now faces a conundrum. It wants to keep interest rates suppressed across the yield curve. At the same time, it also wants to raise inflation rates.

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Mike Gleason is a Director with Money Metals Exchange, a national precious metals dealer with over 50,000 customers. Gleason is a hard money advocate and a ...

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