Reflation Trade: What Is It And What Are Its Implications?

Reflation is a term that expresses the resumption of inflation after a period of deflation. This revival of inflation is affected by the implementation of certain instruments of economic policy such as increasing the money supply and reducing taxation or even lowering interest rates. The monetary injection aims to boost the economy. Reflation can be very costly for governments, especially if the reflation is done by reducing taxes. Do you know what reflation is? How is it different from inflation? There are many such questions that often bother many people. Today we will learn about inflation in this article, its causes and effects, and how it affects our economy. Let’s get started.

Reflation Trade: All You Need To Know

Reflation has a very important place in our economy and in our financial sector. So that the economy of our country can be taken up and down. In financial parlance, reflation is an often mentioned term. We will discuss reflation in detail through this article.

Whenever the government feels that economic activities have stopped due to deflation, then the government gradually does inflation to protect the economic life of the society. This is called reflation. 

Reflation may be defined as inflation deliberately undertaken to relieve depression.

If there are unemployed people and capital goods and if profits are low, then higher prices and incomes are essential, that is reflation, not inflation.

In this way, controlled inflation which is done to balance the economy, is called reflation by modern economists. In both inflation and reflation, there is an increase in the amount of credit and money. The effect of both leads to an increase in commodity prices, but reflation is always deliberately done to ameliorate a situation worsened by deflation, whereas inflation is often circumstantial. This creates a fear of gradual separation of economic conditions.

What is the difference between Inflation and Reflation?

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In both inflation and reflation, the trend of changes in the economy remains the same. In both cases there is an increase in the quantity of money and an increase in the value of goods. 

However, there are some fundamental differences between the two which are as follows:

Start

Inflation is based on a situation which is not controlled by the central bank and the government, but reflation starts from the peak of deflation.

Natural and voluntary inflation

Inflation is circumstantial and causes the economy to deteriorate gradually, whereas reflation is deliberately done to improve the situation arising out of deflation.

Purpose

The purpose of reflation is to simultaneously increase the quantity of money, thereby raising the price level. Inflation has no fixed limit, whereas reflation aims to remove recession and raise the price level by increasing the quantity of money. The increase in the amount of money is stopped after the purpose is served.

Result

The consequences of inflation can be fatal or damaging and the economy can become unbalanced. But reflation creates equilibrium in the economy.

Control

Inflation is difficult to control. Once inflationary conditions are reached, inflation tends to rise. But reflation is deliberate. So it can be controlled to a certain extent.

The pace of price increase

The pace of price increase is very rapid in inflationary conditions, but the price increase in reflation is gradual.

Lastly, it is said that reflation is beneficial to the country’s economy and inflation is harmful.

What are the implications of reflation trade?

The reflation trade, which occurred as the money supply increased and the US economy moved toward a post-pandemic recovery, implies that investors are betting on a return to inflation driven by massive stimulus under the presidency of Joe Biden and a Democratic Congress. This dynamic has caused cycle-sensitive stocks to outperform defensive stocks and value stocks to outperform growth stocks, along with a rebound in commodity prices and higher long bond yields.

But after the Federal Reserve signaled the possibility of rate hikes earlier than expected at the last meeting on June 16, the momentum of value stocks over growth stocks stalled, short-term government bond yields rose strongly and value and cyclical stocks slumped.

Value stocks, which tend to have a low price-to-earnings ratio but solid fundamentals, have risen as much as 17.4% since the start of 2021, as reflation trading took hold while vaccination numbers rose and deaths by COVID-19 decreased. Those stocks fell about 3.8% after the Fed meeting.

Meanwhile, high-tech stocks, which had rebounded during the height of the pandemic but were outpaced by value stocks for most of this year, rebounded around 1.7% after the release was released. Fed forecast.

Reflation trading has also been a boon for cyclical stocks, particularly the consumer discretionary, industrial, materials, financial and energy sectors, which posted an average increase of 22.1% since the beginning of this year. Cyclical stocks tend to perform better during a booming economy and worse during a declining one. 

By comparison, defensive stocks, including utilities, consumer staples and healthcare, have risen just under 5% so far this year. Defensive stocks have proven to provide very stable earnings even during economic recession.

However, the strength of cyclical sectors has been tested by the Fed’s possible initial push for higher rates. For example, the S&P 500 energy sector, which rose by 44% since the year started, went down by 6.7% post the Fed Meeting. Financial stocks, which rose as much as 30% from Early 2021, fell 5.4% after the Fed meeting.

The Fed’s more aggressive swing likely triggered a short-term reversal to growth and mega cap stocks, but the turnover may already be reversing and we continue to believe cyclical stocks are the best place to be.

For the rest, despite the fact that most Fed officials raised their forecasts regarding the timing of the next rate hikes, the ultra-lax monetary policy of the monetary authority, which includes a continued commitment to interest rates close to the 0% and monthly purchases of US $ 120 trillion in Treasuries and mortgage-backed securities, holds. Instead, economic growth remains strong and some upside risks to inflation still persist, before tending to moderate by 2022.  

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