The Great Reflation Trade Is Buckling Around the World

The reflation trade that hammered bonds, drove stock gauges to repeated records and re-energized long dormant value shares this year is in rapid retreat.

Driving the drama is the bond market. Benchmark 10-year Treasury yields broke below 1.3% Wednesday as real rates -- which strip out the effect of inflation -- sank below minus 1%, signaling that traders are souring on the growth outlook. That reignited a bid for the technology-heavy Nasdaq 100 Index, which touched a fresh record as the cyclically-oriented Dow Jones Industrial Average has lagged.

Taken together, the cross-asset picture suggests that investors increasingly see the best days of the so-called reflation trade in the rearview mirror. After surging economic growth resurrected value shares in the first half of the year, “peak growth” warnings have surfaced while inflation expectations -- which once rattled tech shares -- have cooled. Combined with hawkish noises from the Federal Reserve and new virus variants spreading across the globe, the shift is sending traders back into tried-and-true growth names.

“From April to May and into June, you saw a lot of peaking economic data and that is reverberating across assets,” said Matt Miskin, co-chief investment strategist at John Hancock Investment Management. “These things are still growing, but the rate of change is decelerating and the markets are pricing that in.”

Most recently, data on Tuesday showed that U.S. service providers expanded in June by less than forecast, while still indicating demand for services like restaurants, hotels and travel. And Citigroup Inc.’s economic surprise gauge -- which measures the magnitude to which reports either beat or miss forecasts -- has dipped to its lowest level since February.

Elsewhere, there are concerns China’s economic rebound may have peaked. That’s reflected in the more than 7% drop in emerging-market stocks -- touted as one of reflation’s beneficiaries -- from a record in February. Japan’s Topix equity index, perceived by some as a cyclical play, is down about 4% from a high in March, a period over which global stocks rose almost 8%.