How the Reflation Trade Roiled Global Markets in Seven Charts

A roaring reflation trade sent markets on a wild ride in the first three months of 2021, and its lasting reverberations are putting traders on guard for the next wave of volatility.

Global bonds plunged and traditional haven currencies were battered this quarter, while the U.S. dollar proved its resilience even when investors doubted its prospects. The moves came as investors price in a rapid global recovery from the pandemic, albeit textured by regional divergences on vaccination programs and central banks’ willingness to ease super-loose monetary policy.

“There are pockets of idiosyncratic stories in there -- Turkey, Russian sanctions, sterling outperformance -- but generally reflation has been the dominant driver of global price action,” said Simon Harvey, senior market analyst at Monex Europe, who revised his dollar outlook this week. “What wrong-footed most people coming into 2021 is just how aggressive the U.S. outperformance was going to be.”

Some see the end of a quarter as a psychological break between trends. With U.S. yields ending March with another ascent and inflation expectations powering higher despite more subdued hard economic data, investors may start to question how much longer the reopening trade can run.

Here are some of this quarter’s most notable moves:

Treasuries Rout

With the size of U.S. stimulus putting the nation on course for a swift economic rebound from the pandemic, it’s no surprise that U.S. Treasuries led the global rates selloff. They recorded their worst quarter since 1980, according to Bloomberg Barclays indexes. By comparison, the retreat seen in Europe and Asia was in line with quarterly declines seen in 2019 and 2020, respectively.

How the Reflation Trade Roiled Global Markets in Seven Charts

Treasuries extended losses this week, fueled by President Joe Biden’s plans to accelerate the vaccine campaign and rebuild infrastructure. Block sales in U.S. debt were rife on Tuesday, driving yields on various maturities to the highest levels in more than a year.

The divergence between U.S. and European markets was borne out in the spread between benchmark Treasuries and bunds, which widened more than 50 basis points. That about matched the move seen in the final quarter of 2016, and a bigger jump hasn’t been seen since 1993.

How the Reflation Trade Roiled Global Markets in Seven Charts

Ho-Hum Havens

The traditional havens of the currency world -- the Japanese yen and Swiss franc -- bore the brunt of the selling as vaccine rollouts brightened the economic outlook globally. Each suffered their worst quarter in years, with the yen selling off to an extent not seen since 2016 while the drop in the franc was the worst since 2014.

The moves were all the more notable given the outperformance of the dollar, which turned from a prime haven at the height of market turmoil in March 2020 into a bet on U.S. economic supremacy.

How the Reflation Trade Roiled Global Markets in Seven Charts

The pain may not be over, judging by their renewed weakness this week. The yen extended declines beyond 110 per dollar for the first time since March last year, while the franc hit levels last seen in July.

Pound Gain, Euro Pain

The dramatic finale to Brexit trade negotiations at the end of 2020 became little more than a sideshow for the pound in the first quarter. Instead, it was all about the U.K.’s vaccine drive, which far outpaced the European Union’s effort, much to the chagrin of the bloc’s policy makers. That has pushed the euro-pound pair toward 0.85 in what is set to be its worst quarter since 2015.

How the Reflation Trade Roiled Global Markets in Seven Charts

Gilt Angst

Nowhere was the impact of the U.K.’s superior vaccination efforts more evident than in the nation’s government debt market. Holders of British bonds saw their worst quarter in data going back to 2000, according to a Bloomberg Barclays index. The inoculation drive has brought forward expectations for the nation’s rebound, allowing Bank of England policy makers to strike a relatively hawkish tone as they ruled out negative rates in the near-term.

How the Reflation Trade Roiled Global Markets in Seven Charts

EM Resilience?

Rising Treasury yields heightened concern among EM traders in late February and early March, yet that wasn’t enough to throw bond sales off track. Developing nation sovereigns and corporates issued a record amount of dollar-denominated debt on a first-quarter basis, according to data compiled by Bloomberg. The spread between emerging-market hard currency debt and U.S. Treasuries rose seven basis points in the quarter, according to a JPMorgan Chase & Co. index, compared with a 335 basis point jump the same period last year.

How the Reflation Trade Roiled Global Markets in Seven Charts

That said, cracks have started to show on the issuance front in recent weeks as yields extended their advance. Indonesia shrank the size of a debt offering, Russia canceled a bond sale and South African debt saw lower demand than usual, leading some strategists to conclude that developing nations may be in for higher borrowing costs from here on.

Turkey Turmoil

The Turkish lira was the best-performing developing-nation currency this quarter -- that is, until President Recep Tayyip Erdogan’s shock decision to replace the country’s central bank chief. The currency plummeted and extended its decline to more than 10%, leading losses among emerging-market currencies, which were already feeling the pain of a stronger greenback.

While Turkey’s new central bank governor Sahap Kavcioglu pledged tight monetary policy in a bid to calm markets, the lira’s trajectory is uncertain, leaving banks’ forecasts looking more like guesswork.

How the Reflation Trade Roiled Global Markets in Seven Charts

©2021 Bloomberg L.P.

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