Despite today’s surge in global equities, which may be as much driven by the France relief rally as the unwind of recent hedges, the latest attempt to reignite the reflation rally is fading as US Treasury yields have given up on much of the overnight move, following two weaker than expected “soft data” reports, the CFNAI and Dallas Fed, released earlier today.
However, while today’s soft data disappointed, there real reasons are to be found elsewhere. First, as Citi itself points out, discussing its own economic surprise index, Citi’s ESI has slumped and the underlying data has also turned down, and adds that in both cases, this has occurred at levels where previous post 2009 data cycles have turned over.
This also goes back to the previously discussed record divergence between soft and hard data (which has been closing fast in recent days), and where the hard data is struggling to follow the lead of the stronger soft numbers, “bonds at least are still following the hard evidence.”
But there is another, more troubling factor when looking forward, and one which may be a far greater hindrance to the reflation trade in general as well as interest rates in particular.
Recall what Eric Peters said two weeks ago: “Pretty much everything that happened in 2016 can be explained by two things; China and oil prices,” he said. “Literally, that’s it. China’s stimulus-induced rebound and the oil price recovery is all that mattered.“
Well, as we noted recently, the China reflation trade is now fading as a result of the collapse in China’s credit impulse.
Which leaves only oil in the driver seat for the future of the reflation trade. And it is here that a flashing red sign has emerged.
As Citi’s Jeremy Hale wrote over the weekend, “inflation indicators have also turned lower. Key industrial commodities like iron ore and copper have breached supports, Chinese inflation surprises peaked in February and our US ISI will drop sharply in April after the March CPI miss. Oil prices are holding up helped by OPEC supply restraint so far. But the correction to the overshoot in medium term break-evens relative to oil continues.
Which brings us to Citi’s punchline on why it is all up to oil now: “unless oil really surges, year on year comparisons favour a sharp fall in G10 inflation surprises in coming months.“
Below we show what is the most troubling chart for those who still believe that the reflation trade is alive and well, courtesy of Citi:
Today, for whatever reason, not only is oil not “surging” to maintain the stronger year-over-year comps but is unable to catch a bid despite the broader risk-on euphoria (prompting some to ask if there isn’t a fund liquidation quietly taking place in the background).
In any case, if China is no longer a driving force in the global reflation trade (and may soon be contributing to deflation) and if oil can not even rise above $50, then the two key drivers behind the biggest risk-on impulse of the past year – certainly since the Shanghai Accord last February – will no longer be a factor, putting the future of the reflation trade in peril, especially if as has been the case recently, Trump is unable to make headway with his own fiscal spending agenda in the US.
It is also why two weeks after Deutsche Bank capitulated on its own short Treasury trade, Citi said “With all this in mind, we are going long TYM7, the 10y note future, targeting 2% 10y yields with a stop on the generic yield at 2.35%.”