One, but certainly not the only, criticism of the newly-minted “bull market” in US equities revolves around the idea that stocks aren’t priced for policy realities.

Implicit is the notion that because inflation has shown no real inclination to recede where it counts (e.g., in the collection of categories that comprise the Fed’s “services ex-housing” measure), the best-case outcome in terms of monetary policy is “higher for longer.” The worst-case is a resumption of hikes (plural) following an assumed pause at the June FOMC gathering.

It’s useful to distinguish between two types of market observers: Those compelled to deal only in outcomes that might fall within the 68% region of the bell curve and those with the latitude to editorialize around scenarios further out in the tails. The former group is focused on one prospective additional Fed hike and what it would represent. The latter ponders more extreme possibilities, including a scenario where inflation refuses to roll over, and terminal is well north of 6%.

The keen among you will note that the nature of inflation can render the normal distribution even more unreliable than we already know it to be. As inflation broadens out and entrenches, inflation tail risks can “realize” via a set of interconnected, self-fulfilling prophecies. That’s why it’s so treacherous. And that’s why the second type of market observer mentioned above would invariably scoff at the suggestion that the “one more hike” contingent has a good grasp of what is and isn’t “likely.”

The “one more hike” camp (most of Wall Street) spends a lot of time thinking about what that prospective last increase would convey. If it’d be a token gesture from the Fed in recognition of inflation’s persistence or, relatedly, if any additional increase would be meant as ostensible “proof” that policymakers are willing to do more if necessary, it’s arguably a meaningless endeavor. It might even be counterproductive if it’s seen, in hindsight, as the straw that broke the camel’s back from a market psychology perspective (mechanically, another 25bps isn’t going to make much difference either way).

As one US rates team suggested recently, the last thing Jerome Powell wants is to inadvertently trade seven months at terminal for one measly, mostly symbolic, final 25bps hike. In other words: The choice between i) leaving well enough alone and staying at terminal for the rest of year and ii) hiking one more time just to say he did at the risk of destabilizing markets such that the Fed is compelled to reverse course almost immediately, is no choice at all. It’s far preferable to hold a lower terminal through year-end than achieve a slightly higher peak for a few months.

That’s a pretty tedious discussion. Certainly, it’s not as exciting as debating tail outcomes, particularly when the tails are fat, as they tend to be once the inflation genie is loosed. As JonesTrading’s Mike O’Rourke argued this week, it’s not entirely clear that Fed policy is, in fact, onerously restrictive. If it’s not, the door’s open to an even longer battle to contain price pressures. “The two measures we believe are most important in illustrating how tight or loose policy is are the real Fed funds rate and financial conditions,” O’Rourke said. “Neither metric is anywhere near the tight levels necessary to slow the economy.”

Given that, it’s reasonable to ask whether stocks are, in fact, too sanguine about upside risks to the terminal rate, particularly given that rising stock prices can themselves create that upside risk (as the Fed worries about the read-through of a rekindled wealth effect for inflation). One way of getting at that is to measure if equities are appropriately priced for prevailing levels of inflation uncertainty.

That’s hardly a straightforward exercise, but JPMorgan’s Nikolaos Panigirtzoglou took a shot at it. The bank uses the exponentially weighted five-year moving volatility of YoY CPI (which places more weight on recent observations) to measure inflation uncertainty in fair value models of 10-year yields and the S&P.

That measure has moved lower of late, consistent with falling dispersion among professional inflation forecasts and a sharp drop in inflation surprise indexes. Nevertheless, uncertainty is elevated, as the figure shows.

To bury the lede from JPMorgan’s analysis would be to bury readers in a fairly laborious modeling exercise. I’ll spare you. Suffice to say rates are, in Panigirtzoglou’s words, “still pricing in a sustained period of elevated macroeconomic uncertainty, even if there has been some modest decline over the past three months.” Equities are another story entirely.

The red dashed line in the figure below illustrates JPMorgan’s fair value model for the S&P assuming stocks ignored the increase in macro vol catalyzed by the extraordinary confluence of events that’ve transpired in the 2020s.

So, stocks are trading rich to fair value even if we assume they look past the pandemic-inspired spike in GDP vol and the market increase in inflation vol. As Panigirtzoglou put it, “equities are, if anything, pricing less macroeconomic uncertainty than before the pandemic.”

You can probably guess what the black diamond in the figure represents. If not, Panigirtzoglou was kind enough to spell it out. That annotation “shows a scenario where we assume the market prices in a rise in inflation vol to [levels] consistent with what bond markets appear to be pricing.”

The implication from the model is 20% downside to current levels for equities. One might be inclined to quip that the bull market was over before it started, or at least according to bond-implied levels of inflation vol.

“There is still a large disconnect between bond and equity markets in terms of pricing macroeconomic uncertainty,” Panigirtzoglou wrote, concluding. “Equity markets look ‘priced for perfection.'”