Many investors have already shifted into cyclical sectors, expecting to capitalize on the “reflationary” trade. For example, financials stocks rallied this year as longer-dated Treasury yields increased. However, investors should note that if the Federal Reserve hikes short-term rates to dampen inflation, the yield curve would flatten, so “the spread between borrowing and lending narrows for the banking sector and results in a net interest margins squeeze,” according to BCA Research.
“Depending on how far up the inflation expectations you want to move, financials benefit and then at some point they don’t,” Jack Janasiewicz, portfolio manager at Natixis Investment Managers, told Reuters.