Understanding Reflation—and Why It Matters

WITH THE ECONOMY STRUGGLING TO RECOVER amid an ongoing pandemic, the Federal Reserve (Fed) has committed to a steady process of “reflation"—stimulus aimed at returning a weakened economy back toward normal, healthy levels of growth and inflation. While such tactics are nothing new, “the current reflationary process may be the strongest we've seen in decades," says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. That could mean opportunities on several fronts for patient, strategic investors, Hyzy says.

“The Reflation Triangle," a new report from the Chief Investment Office, points to three reasons for optimism that we're entering a period of extended, controlled growth. First is the trillions of dollars of stimulus and liquidity the Fed, Congress and governments worldwide have unleashed to help markets, consumers and businesses. Second is a weakening dollar—good news for U.S. exports and a sign of renewed global economic confidence. Finally, a steepening yield curve—with interest rates for long-term bonds rising faster than for short-term bonds—may signal increasing market confidence in the economic recovery. 

What it could mean for investors 

Investors remain nervous about reentering the markets, especially for stocks, Hyzy says. “We're still seeing higher flows into bonds than stocks because the 'wall of worry' is still high." Yet investors may want to consider adding stocks and other assets with higher growth potential and greater risk as part of a well-diversified portfolio, he adds. Some investors may want to consider tangible assets such as real estate, timber or farm or ranch land.  “These could generate cash flow while providing a hedge against possible future inflation," he says.

It's important to recognize risks that could still derail a recovery and set back the reflation process. Top among these would be a major “second wave" of the pandemic. At the same time, he adds, “it's important to plan for what appears to be the early stages of a long-term global expansion."