Reflation has been the big theme since November and the driver of most financial markets. However, we believe some of the engines fuelling reflation are set to lose steam over the next three months. The main drivers behind the reflation theme have been an acceleration in the business cycle, a sharp rise in inflation and expectations of fiscal stimulus in the US. We believe all three factors are peaking - or close to a peak.
With reflation set to lose steam, the fuel for the bond bear market is tailing off. In addition, a correction - or a pause - in the equity bull market is normal when the economic acceleration phase is over. We are still long-term equity bulls though, as we do not expect a sharp economic slowdown. We believe EUR/USD is set to move lower short term, but higher long term. Emerging market demand is set to stay high due to the search for carry.
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