A great dichotomy in global markets arises, detracting investors' attention from what is really going on across the world economy. On the one hand, western equity and bond markets ebb and flow according to what the new US president does or twits, and on the other hand the reflationary trade reigns supreme in markets outside of the US, especially in EM economies. The hyper sensitivity of US markets to domestic policy actions creates too much noise, masking the genuine acceleration of the rest of the world. Global commodities (NYSEARCA:DBC), currencies (NYSEARCA:UDN), and sovereign bond markets (NYSEARCA:BWX) witness a second phase of reflationary euphoria, which should be put on investors' radar. Investors should pay close attention to ex-US macro developments which might prove to be decisive even for US markets. After all, we still live in a globalized world where international forces shape the destiny of markets, and unless or until this setup reverses completely, investors ought to keep a close eye at developments and financial patterns to the other side of the planet too.
Reflationary Behavior Outside Of The US
Asia Pacific, in particular, has been a region exhibiting great resilience lately, with intense reflationary signals. In this light, the Aussie dollar (NYSEARCA:FXA), a typically pro-cyclical currency closely tuned to the Asia Pacific business cycle, is exhibiting one of its fastest rebounds in recent years. The AUDUSD exchange rate gained more than 6 big figures in the first five weeks of the year alone, a pretty impressive record for such a currency, following early bullish signals.
The strong bidding of the Aussie dollar was mainly driven by a positive spike in Australia's trade balance, the difference between what the country receives from exports and what it pays for imports, in the biggest surplus creation the country has witnessed in its modern history. This pattern provides strong evidence in favor of the acceleration of the reflationary cycle in the region, since Australia's economy (NYSEARCA:EWA) is very closely tied to the Chinese and broad Asian Pacific manufacturing cycle. Australia supplies the region's factories with the necessary natural resources to be used as inputs in their production lines, and it seems that there is great demand of them. This demand fuels a strong and persistent rally in commodities.
In fact, the global commodities rally can be broken down into two distinct phases. The initiation phase of early-to-mid last year and the acceleration phase which began in mid-autumn. Take, for example, the aluminum market. Aluminum's price followed a pretty typical bullish trend in 2016, beginning from the multi-year low level of $1,450 a ton, as indicated by the trendline A. However, since mid-autumn 2016 aluminum price accelerated its ascent (indicated by trendline B). Currently it is heading towards a retest of its late January highs of $1,880 a ton.
A pretty similar double phase dynamic is evident in Zinc's price behavior. Zinc, a substance widely used in manufacturing of metal alloys, coatings, and in various industry applications, exhibited a strong uptrend last year (trendline C). However, Zinc increased the pace of its rise since mid-October 2016 (trendline D).
Copper (NYSEARCA:JJC) exhibits a slightly different, albeit bullish, pattern. After completing a sizeable bottoming triangle formation in November of 2016, it began a fierce rally towards the $2.70+ a pound area producing a highly bullish setup. With such generalized commodities' strength, though, it should come as no surprise that producer price pressures accumulate all over Asia fueling expectations about inflationary pressures at the consumer level as well. This is especially prevalent in the bearish behavior of Asia Pacific bond markets.
Bond Markets Confirm The Reflationary Setup
As a matter of fact, since the beginning of this year Asian bond markets experienced selling pressure. At the same time US Treasuries (NYSEARCA:TLT) received some buying support which stabilized their yields. Chinese 10-year yields re-approached their sixteen month highs of 3.4% while US 10-year yields fell back to 2.45%, a level they have been trading around the turn of the year. More interesting, though, Japanese 10-year yields are breaking out to the upside their December-January consolidation range, signaling fears about reflationary pressures. This bearish bond move comes despite the still active yield curve targeting policy by BOJ! Other Asia Pacific bond markets like Australia, New Zealand, and Taiwan, also confirm this bond bearish dynamic, exhibiting a steady uptrend in their long-term bond yields.
That said, a reflationary trend seems to dominate Asia Pacific, not only across different geographical markets but across different assets classes, i.e. fixed income, commodities and currencies. This synchronization of market forces is too strong to be only circumstantial. There is substance of real economic activity behind these reflationary patterns, and this activity seems to be strengthening by the day.
There are, of course, some minor blind spots in the big reflationary picture, such as the recent bearish reversal of the Baltic Dry Index, i.e. a gauge of shipping costs of dry commodities. However, this is an isolated signal for the time being which might have to do more with increased vessel supply than a drop in the underlying demand for dry shipping. Furthermore, this ubiquitous reflationary market behavior in Asia Pacific is accommodated by persistent surprises from macro releases, such as the latest announcement of the better than expected Chinese manufacturing PMI for January.
Global capital and financial markets do not seem currently so global; a dichotomy arises between the steady reflationary patterns of Asia Pacific and the volatile behavior of US markets. While the day-to-day policy decisions of the new US administration are becoming the main driving force of short-term price fluctuations in US and even European markets, asset classes which are more tightly connected with emerging markets (NYSEARCA:EEM) are telling a different story. As long as the US dollar (NYSEARCA:UUP) remains weak, emerging markets could be expected to benefit from increased USD funding, widening the divergence between the reflationary signals of the East and the concerns of the West. This will drive EM bond yields (NYSEARCA:EMB), pro-growth currencies, and even commodities which have lagged the reflationary trade like agricultural goods (NYSEARCA:DBA) to outperform, eventually producing second round inflationary effects to these economies.
However, sooner or later this gap will have to eventually close either with a decisive pro-growth policy implementation in the US which will establish a new up leg in US equities (NYSEARCA:SPY) or with highly disruptive policy choices which could even lead to stagflation. The momentum of truth approaches, but investors can still hope for the better; the global economy has the spontaneous power to accelerate and it provides daily evidence. Will the new US administration take this opportunity on its side? Take your bets.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The views expressed in this article are solely those of the author, provided for informative purposes only and in no case constitute investment advice.