Reflation trade fueled ahead of Yellen testimony

Asian stocks have set a risk on tone for Tuesday’s trade. Regional indices are firmly in the green with US futures powering higher ahead of tonight’s cash session, post US markets holiday closure on Monday.

The data docket is light but Treasury Secretary nominee Janet Yellen has a Senate confirmation hearing later tonight which traders are looking ahead to for further confirmation of the reflation trade which has so far dominated the tape action of 2021. Yellen is expected to spruik the $1.9trn already on the table to the Senate Finance Committee and urge lawmakers to “act big”. Following a moment of consolidation turnaround Tuesday is in action today, with the reaction to Yellen’s testimony to set the tone for momentum throughout the week. The weaker dollar all-important for the near term outlook of inversely correlated reflation trades.

The dollar has remained on the back foot in today’s trade, anticipating further confirmation of the Yellen Treasury MMT-lite shift – More stimulus, more spending, more borrowing. With Yellen on course to stress the importance of demand side policy in rectifying a K-shaped economy and righting prior policy errors that have exacerbated these structural issues. Again highlighting a shift toward fiscal primacy with a focus on lowering inequality, unemployment and maintaining demand, particularly for the bottom leg of the ”K”. This regime shift for fiscal, combined with supply side pressures, is a perfect storm for higher inflation.

With these shifts in mind, the name of the game in asset markets remains one of reflation.

Container freight costs, ISM price gauges, PMI surveys, food price indices and the recent run in commodity prices all point to price pressures already present on the supply side. Coupled with an aggressive demand bounce back accompanying vaccine rollout, the impact of Covid related supply bottlenecks and green policy agendas, headline inflation will not be hard to achieve - especially against incoming low base effects.

On the demand side, the prospect of a unified government in the US with unimpeded fiscal stimulus puts upward pressure on inflation and long bond yields, whilst the USD is debased and that is fuel for emerging markets, Asia, commodities and bets on higher inflation.

We expect the broad commodity rally seen throughout the last quarter to extend throughout 2021. Huge supply deficits with structural underinvestment, green transformation tailwinds, fiscal primacy and the engines of a weaker dollar plus higher inflation, coincide with a historic underweighting and a multiyear bear market to bring renewed interest in the space and a new bull market that is just getting started.