Increasingly, we find ourselves thinking about the limits of the reflation trade. Admittedly, our research team has been aggressively bullish on global reflation, especially beginning 2021. However, we think it is time to start orienting towards a regime shift. Now, this doesn’t mean that we abandon our reflation positioning across investments. Rather, it means we start looking for the tell-tale signs of a regime change from reflation to a moderate expansion. We think the context below is important, particularly for EURUSD, JPYUSD, and DXY:

Above, we show our model-driven estimates of future Industrial Production for the UK, US, and Japan. We use industrial production to measure global business activity, and our models are pointing to peaking YoY numbers in June-July of 2021. Markets are forward-looking, and as we would expect, they have already priced in the numbers, which can be seen in our global risk appetite measures (defined as total equity allocation):

As we can see above, our risk appetite measures have started to come down after posting record-highs earlier this year. We think this is largely a function of markets beginning to price the next phase of the global economic recovery, i.e., one where growth will continue, but its pace will likely decelerate. This is consistent with the currently elevated levels of global growth expectations, making it hard for growth expectations to increase further:

As we can see, the consensus forecast shown above is already pricing in a high rate of recovery for major economies. Hence, we see little room for these to continue to climb substantially. As such, we need to start monitoring the situation carefully to assess when we are definitively in regime change. Particularly, we think that the best information to gauge reflation narratives is embedded in major economies’ equity markets. We will be watching price action, implied earnings growth, asset allocation, and momentum carefully. For the time being, reflation looks like it continues. However, we need to start looking for the next regime shift.