As recently as May, Wall Street was fretting about the long-heralded return of inflation . A sharper-than-expected economic rebound from pandemic-induced lockdowns that was powered by unprecedented amounts of stimulus and the optimism generated by vaccines led to a surge in consumer prices , especially in the United States, where fears of overheating were rife. Fast forward two months and concerns about the spike in inflation have been supplanted by mounting anxiety over a slowdown in the global economy. The reflation trade – which hammered government bonds in the first quarter of this year and drove a rotation from “stay-at-home” stocks to sectors benefiting from the reopening of the economy – has lost its fizz. This is most apparent in the unexpectedly sharp decline in the yield on benchmark 10-year US Treasury bonds, which has fallen from 1.7 per cent in mid-May to 1.4 per cent. The real yield, which strips out the effects of inflation, has dropped to minus 0.97 per cent, more or less where it stood before the reflation trade gained momentum in February. In the past few months, it has become clear that market expectations about the strength of the recovery and the availability and deployment of vaccines were overly optimistic. The sudden reassessment of the pace of growth and the threat posed by the virus has increased investors’ sensitivity to signs the world economy is slowing. Markets have been particularly perturbed by the slowdown in China’s economy , partly because the country led the world out of lockdown last year and was ahead of other major economies in returning to pre-pandemic levels of activity. This is why the People’s Bank of China’s decision last Friday to cut its reserve requirement ratio for most banks – the first reduction since the darkest days of the pandemic early last year – was seized on by investment strategists as a sign of the seriousness of the threat to global growth. However, fears about China’s recovery need to be put in perspective. While Beijing is clearly concerned about a sharper deceleration in the second half of this year, it is also acutely aware of the need to manage market expectations at a time when the revival of China’s deleveraging campaign has unnerved investors. The monetary easing is aimed at allaying fears that Beijing is tightening policy too aggressively. China’s economic balancing act – supporting growth while curbing financial risks – has been a key theme in markets for years. The latest cut in the reserve requirement ratio has come under scrutiny not because of a sudden China-induced growth scare, but because it feeds into a narrative suggesting the global post-pandemic boom has passed its peak. Just a cursory glance at the findings of Bank of America’s latest fund manager survey, published on Tuesday, shows worries about growth are broad-based. They stem mainly from economic and virus-related developments in the US and Europe. The net percentage of respondents who expected higher global consumer inflation – which is stronger in the US than it is in China – in the next 12 months plummeted from 93 per cent in April to just 22 per cent. However, while growth expectations also collapsed, investors’ allocations to commodities were at an all-time high. This is hardly suggestive of a loss of confidence in China’s economy. The main reason the reflation trade has suffered is because investors are questioning the strength of the US economy. For the first time in more than a year, US economic data is no longer beating expectations, according to Citigroup’s US Economic Surprise Index. Just as importantly, US President Joe Biden has had to scale down his infrastructure spending plan , just as the Federal Reserve is proving more responsive to inflationary pressures. The central bank announced last month that it expected to begin raising interest rates sooner than markets anticipated. In Europe, the rapid spread of the more infectious Delta variant of Covid-19 has caused a spike in infections. In the United Kingdom, the government will lift nearly all remaining restrictions on July 19 in the face of a surge in new cases and, more worryingly, an increase in hospitalisations. The fierce resurgence of the coronavirus in Britain – whose vaccination roll-out has been one of the most successful in the world – has further undermined sentiment, making the endgame of the pandemic more uncertain. Still, even though threats to growth have become more pronounced, markets are overreacting. Inflationary pressures have hardly subsided. Data published this week showed that core inflation in the US rose to 4.5 per cent last month, its highest level in 30 years. The Fed’s view that the surge in prices is temporary is being challenged more forcefully. Moreover, the post-pandemic recovery remains robust. While growth rates are slowing, they are coming down from the stratosphere as the explosion of pent-up demand gives way to a more sustainable expansion. The International Monetary Fund still expects brisk global growth of 4.4 per cent next year. China’s economy faces severe challenges, but the problem right now is market expectations. Excessive exuberance has given way to undue pessimism. Nicholas Spiro is a partner at Lauressa Advisory