Re-inflation trading heats up

Entering February 2021, global commodity prices continued to rise. The prices of Brent crude oil and WTI crude oil in the United States both exceeded US$60/barrel, and the price of copper in London increased by more than 15% to US$9,300/ton. The domestic South China Industrial Products Index rose by more than 12% in February, breaking through 2,900 upwards, surpassing the 2011 high.

The logic of the rise in commodity prices is the warming up of “re-inflation” expectations. The current main factors driving re-inflation are the popularity of the new crown vaccine and the US economic stimulus policy. It is worth mentioning that although the central banks of developed countries are fully fired and have implemented loose monetary policies for a long time in pursuit of the inflation target, they are still far away from the realization of the target in these years. On the contrary, in the new crown epidemic, with the interruption of the supply chain and the fiscal budget. The introduction of stimulus policies and the formation of a pattern of inflation have even made the market worried about the conversion to inflation.

In the face of rising expectations for re-inflation, investors need to distinguish whether this phenomenon of price rebound is a long-term sustained inflation risk or a phased phenomenon. From the perspective of the domestic situation, in the context of the social financial turning point and the economic turning point not far away, and the regulatory authorities have begun to pay attention to the broad inflation included in asset prices, the probability of continuous demand outbreaks or full-scale asset bubbles is very low. . But in contrast to the United States, after the Fed put a huge amount of money, the trend of rising inflation became more and more obvious, just like a rushing gray rhino.

What is reinflation?

Re-inflation (reflation) or re-inflation is a measure deliberately taken by policy departments in order to keep prices in a normal range or reduce unemployment. By increasing money supply or stimulating demand, companies are encouraged to expand production and avoid entering deflation.

Different from inflation (inflation), the re-inflation policy measures are relatively mild, and the fundamental purpose is not to generate inflation. At this time, there is a partial implicit price increase pressure when the overall price is not high, but it is not Continuous demand expansion. In contrast, the main driving factor behind inflation is the strong demand of the economy itself. For example, consumers increase spending due to rising incomes, companies are optimistic about future market demand and increase investment, or government departments are demanding due to policies. And continue to expand the deficit. In addition, market entities are hoarding goods due to the expectation of continued price increases, forming inventory investment, which is also an important factor in demand-driven inflation.

In the process of re-inflation, the financial sector will be relatively restrained because it is cautious about the long-term economic prospects and lacks confidence in the ability of enterprises to repay. Financial institutions do not have sufficient incentives to lend in large quantities. The process of forming inflation is different. The financial sector will actively contribute to the flames and provide a large amount of debt financing to support the expansion of demand in the real sector, such as mortgages, consumer credit, corporate operating loans, debt issuance and other tools, which will eventually lead to the physical sector. Excessive leverage.

From the above comparison, it can be seen that although there are many differences between re-inflation and inflation, the most fundamental thing is the strength of the expansion momentum of economic demand. However, this boundary is not clear-cut. Once the economic self-repair momentum is strong and growth continues to pick up, or the implementation of stimulus policies is too strong, the economy will also be under pressure to transform from re-inflation to inflation. Therefore, policy flexibility and moderation are very important.

Global reinflation pushes up U.S. interest rates
The global spread of the new crown vaccine is now racing against the spread of the epidemic. Research by the Economist Intelligence Unit (EIU) shows that the United Kingdom and the United States are currently in sufficient supply of vaccines because they have sufficient financial resources to invest in vaccine research and development, thus leading the world. Advanced economies such as Canada and the European Union lag behind the United Kingdom and the United States.

China is also stepping up efforts to promote vaccination. According to data quoted in an article published by Gao Fu, an academician of the Chinese Academy of Sciences and director of the Chinese Center for Disease Control and Prevention, as of February 3, China has received 31 million doses of inactivated COVID-19 vaccine.

The popularization of vaccines will bring about stronger global economic growth, but the US economic stimulus policy does not mean to withdraw, but may continue to increase. The U.S. Senate and House of Representatives have passed the Biden administration’s $1.9 trillion stimulus plan. In an interview on February 19, US Treasury Secretary Yellen called for a large-scale fiscal stimulus to be launched as soon as possible in order to fully recover the US economy. The Federal Reserve announced in its semi-annual monetary policy report on February 20 that it will maintain the current bond purchase speed until the goal of inflation and a full economic recovery is achieved.

Investors need to pay attention to the trade-offs behind the US economic stimulus policy. In Yellen’s statement to the U.S. Congress, she stated that the new crown pneumonia epidemic has devastated extensively and that the U.S. federal government has taken further actions to avoid a longer and painful recession and long-term trauma. Yellen also emphasized that interest rates are now at historical lows, and it is a wise choice for the federal government to take action to support the economy. The benefits of fiscal stimulus measures outweigh the costs of high debt.

Yellen’s concerns are largely due to structural unemployment and permanent unemployment in the labor market. According to recent data released by the US Department of Labor, the US unemployment rate in January was 6.3%, a decrease of 0.4 percentage points from the previous month, but the non-agricultural sector added only 49,000 new jobs; in January, the number of unemployed people in the United States fell to 10.1 million, which is permanent The population remains at a high level of 3.5 million people.

Yellen judged that if a sufficiently strong stimulus package is introduced, the United States is expected to return to full employment in 2022.

Nevertheless, the high debt problem in the United States is enough to make investors vigilant, and it is necessary to pay attention to the risk of premature tightening of the Fed when it is close to full employment. In the aforementioned semi-annual monetary policy report, the Federal Reserve warned that the current level of corporate borrowing is close to historical highs. Even if the economy recovers from the new crown epidemic, companies are also facing a high risk of bankruptcy.

Moreover, driven by inflation expectations, U.S. bond yields have hit record highs. Although the Fed is holding down short-term interest rates, long-term U.S. Treasury interest rates have risen. The current 10-year U.S. Treasury yield has risen to 1.37% and the 30-year yield has risen to 2.21% (Figure 1). The rise in interest rates tests the patience of US fiscal and monetary policies.

Figure 1: Long-term U.S. Treasury interest rates are on the rise

Source: Wind, Pengyang Fund

China’s monetary policy may be pre-adjusted ahead of the tightening of the Fed’s monetary policy. Therefore, given that the social financial turning point has already appeared in the fourth quarter of 2020, the turning point of economic growth in 2021 will not be too far away.

Controllable domestic inflation risk
China’s domestic prices are also in an upward channel in the short term. In January 2021, the CPI was significantly affected by the dislocation of the Spring Festival, from a year-on-year increase to a decrease; from the data’s month-on-month trend, non-food products were mainly affected by crude oil prices and showed a month-on-month rebound, while other sub-items remained weak overall.

As domestic demand continues to improve with the control of the epidemic, and the prices of international commodities such as crude oil and iron ore continue to rise, the PPI data continues to rise sharply. After 18 consecutive months of negative year-on-year PPI, it turned positive for the first time in January 2021.

According to the forecast of the Pengyang Fund, China’s CPI operation center will be around 2% in 2021, and the recovery is mainly driven by the repair of non-food item prices and the increase in crude oil prices. The PPI operating center will be around 1.6%-2.5% (Figure 2). The high point will be in the second quarter. Under extreme scenarios, the high point will be 4.5%. The PPI will fluctuate within a range in the second half of the year.

Figure 2: The high point of PPI in 2021 is expected to be in the second quarter and fluctuate within the second half of the year

Source: Wind, Pengyang Fund

However, unlike the United States, China has not adopted a flooded monetary policy in recent years, and production and supply have recovered relatively adequately after the epidemic. Apart from the rapid economic recovery, there is no obvious internal inflationary pressure. The gradual recovery of overseas production and supply in the future will also divert part of external demand. As monetary and fiscal policies turn steadily, the phenomenon of re-inflation will subside, and the need to prevent deflation risks is not even ruled out.

From a short-term perspective, as the price level was in a recovery phase in the first half of the year, commodities and stocks performed well, and bonds were defensive in the short-term. From the perspective of industry fundamentals, some industries will benefit from the accompanying phenomena of re-inflation, such as the rebound in product prices and the widening of interest margins. Considering that the final implementation scale of the US fiscal stimulus plan may shrink, and China’s monetary policy may also be pre-adjusted ahead of the tightening of the Fed’s monetary policy. Therefore, when the social financial inflection point has already appeared in the fourth quarter of 2020, 2021 The inflection point of economic growth in 2015 will not be too far away, and there will be a new rotation in equity and debt.