“From where we are sitting, the market remains clueless about where 10-year bond yields or interest rates should be right now.”
So said SocGen’s Andrew Lapthorne on Monday, in a note expressing some skepticism about the increasingly fortuitous conjuncture implicit in earnings estimates and market pricing for the Fed.
Long story short (because I’ve subjected readers to the long version at least half a dozen times since Chris Waller’s game-changing remarks late last month), the market’s collective faith in a best-case 2024 conjuncture defined by rising profits, decent growth and rate cuts, is increasing.
Last month’s bond rally and the tidal wave of dovish rates wagers may be indicative of an epochal shift in the market’s thinking, but as Lapthorne noted, the net effect was that yields and Fed pricing are now roughly back to where they were midway through summer. Hence his “clueless” characterization of the US rates complex.
As someone who harbors an exceedingly dour view on… well, on everything, really, I’m sympathetic to the notion that things won’t go as planned in 2024 and that the odds of a best-case “immaculate slowdown” are as vanishingly small as bears and pessimists have long contended.
However, I try to separate my grim worldview (which, in a nutshell, says that everything we do is meaningless by virtue of the incontrovertible fact that even after a century and a half of what, for us, counts as warp-speed progress, we’re still a hopelessly backward species destined for some type of extinction event on a floating rock orbiting a dying star) from my near- and even medium-term views on macro, markets, policy and asset prices.
In that context, I’m compelled to admit that the chances of an unimaginably benign outcome are actually higher than they probably should be, simply because there’s no modern historical precedent for recent events. And past anyway isn’t always precedent.
If past were precedent, though, we’d be in trouble. The “idea of an immaculate slowdown” entails rates falling “as inflation go[es] back to target yet corporate profitability grows at a double-digit rate while prior interest hikes neither damage demand nor balance sheets,” an incredulous Lapthorne wrote Monday.
As the chart shows, such an outcome, at least in terms of profits and Fed cuts, would be unusual to put it mildly.
“As quants, we clearly suffer from a backward-looking bias,” Lapthorne went on to joke. “But rates cuts and profit growth? We’ve yet to see it.”
Related: Bears, Bulls And The 1950s Parallel
I was curious why SG uses MSCI World profit growth. when the Fed is US-focused.
https://fred.stlouisfed.org/graph/?g=1cbaG is an analogous chart, using US Corporate Profits After Tax and Fed Funds Effective Rate, 2Q2054 to 2Q2023.
That chart reads a lot like the SG chart. But if you actually count the quarters when FF declined from prior qtr AND corp pft gro was positive, there’s actually 67 such quarters out of 276 (24%).
I’ll ignore the one-offs, when FF was down for an isolated quarter during a stretch of positive profit growth; the Fed may have once allowed FF to fluctuate more than it does today, some of its tools for controlling FF were developed in the last couple decades. Maybe also ignore the two-offs. to allow for some hysteresis.
We’re still left with 1Q1990 to 3Q1992 when FF declined every quarter (from 8.25% to 3.04%) while profits grew; 2Q1995 to 1Q1996 ditto (6.02% to 5.24%), 2Q2002 to 3Q2003 ditto (1.75% to 1.0%). That is 21 quarters out of 276 (8%) when FF was in multiple-consecutive-qtr decline from prior qtr AND corp pft gro was positive.
Maybe we should use different metrics – these were just handy to plot and download from FRED. We could also combine with inflation to look at real FF. But on first glance, I am not as incredulous as SG.
Lapthorne isn’t US-based. He’s global quant strategy. But you make a good point regardless.
So John, I just got word: That chart was mislabeled, apparently. It’s actually MSCI USA profit growth. I used some digital Wite-Out to correct it.
Thank you for catching that.
Final update: I replaced the chart with the “official” version. I honestly can’t tell if it’s any different (i.e., whether it’s just an elongated version of the first one or an actual new chart with a new series), but whatever the case, the one that’s in the article now is the correct one, apparently.
To link this with another post by our host, I think it matters a lot WHY the Fed is cutting rates… If it’s because inflation is tame and they see no reasons to be constrictive just for the fun of it, there’s no reasons lower rates cannot coincide with expanding profit margins or solid revenue growth…
If they’re cutting rates b/c the economy is weak, well, then, d’oh, expanding profit margins is a lot less likely…
Anyone have handy recollections of the WHY in the time periods I mentioned?
1990 was around the Gulf War and oil price shock and related slowdown.
IDK about 1995-96. Bard (Google chatbot) suggests worries about a Japan slowdown might have contributed, but that doesn’t register with me.
2002-03 was the post-bubble bursting that seemingly would never bottom, but that’s just a guess.