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CROSS ASSET WEEKLY
26.02.2021

Global reflation proceeds

Summary
Cross asset weekly pic
Mirroring higher vaccination rates and the prospect for a stronger fiscal impulse, economic indicators this week improved more strongly in the US than in continental Europe. The same goes for inflation rates, which are likely to exceed central bank targets temporarily, both in the US and in the euro area. Against this backdrop, the Fed and the ECB had the same clear message for financial markets this week: They do not intend to tighten financing conditions anytime soon. Fed chairman Powell stressed that he would like to see more evidence of an improving economy and a sustained increase of inflation expectations while ECB chief economist Lane reiterated the central bank’s focus on financing conditions. Nothing seems less desirable than an undue tightening of financing conditions against an improving yet fragile macroeconomic backdrop. We therefore look at a few indicators reflecting financing conditions at various stages of the monetary policy transmission. What seems clear, is that central banks would welcome higher inflation rates but currently would limit the upside for real yields. This has implications for equity markets which we are also looking at this week:
Equities generally provide a good hedge against high and rising inflation, given companies’ ability to employ their operational leverage and grow revenues faster than their cost base. We agree that equities are a good hedge, but caution against too much confidence, given the link between rising inflation rates, real rates and valuations. This does, however, still leave room for different sectors to benefit to a different degree at different stages of the cycle. In a reflationary environment, energy and financials are best placed. Later in the cycle, when inflation is closer to its peak and less driven by oil prices, defensive sectors, such as staples and utilities appear to be well placed.

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