US election sucks air out of the reflation trade

US election sucks air out of the reflation trade

Prospect of divided Congress and more modest economic stimulus has had big effect on markets

Among those whose hopes were dashed by the weaker than expected performance of the Democrats in the US election this week: investors who had bet on a speedy and significant return of inflation.

The reflation trade appeared to have been effectively extinguished by signs that the US Senate is likely to remain in Republican hands, even if Joe Biden wins the White House. That would be a recipe for legislative gridlock, reducing the prospects for a second major injection of fiscal stimulus.

As election results rolled in, money managers dialled back wagers on a spending-fuelled economic boost that would feed through to inflation. Their shifting bets propelled a sharp rally in Treasuries and pushed US break-even rates — a market proxy for inflation expectations — to a one-month low. The 10-year break-even rate, derived from prices of inflation-protected government securities, fell 0.09 percentage points to 1.65 per cent.

“Markets have realised that the reflationary trade is now dead,” said Seth Carpenter, chief US economist at UBS. With a divided Congress, a plan for “any sort of big fiscal, reflationary, transformational proposal is gone”.