US rates bear flattened ahead of this week’s key macro data, perhaps not surprising on the heels of what it’s probably fair to call a near-term dovish overshoot.

Recall that two-year yields fell more than 35bps last week, one of the most pronounced rallies in recent history.

The impetus, obviously, was rate cut speculation, fanned by Chris Waller. Many suspect it’s overdone, or at least if you don’t want to posit a recession. “With roughly 135bps of easing priced by December 2024 (and nearly 60bps of cuts to the Fed funds rate by next June), we think markets are approaching the limits of what can plausibly be priced without attaching material odds of a recession in the near-term,” Goldman’s Praveen Korapaty said, adding that markets may be “overinterpreting” Waller’s comments.

Whatever the case, it does seem quite likely that front-end rates (and the policy rate) have peaked. In that regard, strategists are once again looking at equity returns post-peak rates by inflation regime. The figure below is from Morgan Stanley’s Mike Wilson.

Wilson exhorted investors to observe “the strong disparity in performance between cycles where inflation was historically elevated when the first cut was delivered versus those where inflation was not historically elevated.”

The (familiar) implication is that because inflation is elevated this cycle, investors should be cautious about extrapolating post-peak rates equity returns from cycles where it wasn’t, particularly in light of high valuations. It also matters (tremendously) where we are in the cycle.

“The cycle peak in front-end rates is typically a bullish signpost for equities assuming inflation is contained; when inflation is not historically elevated or retreats as growth is slowing, the Fed is able to pivot proactively to a more accommodative policy stance with cycle runway left, fostering strong equity returns,” Wilson wrote Monday. “On the other hand, if inflation proves to be sticky despite slowing growth, the Fed typically maintains restrictive policy later into the cycle, only cutting rates when the growth backdrop deteriorates significantly.”

The message from stocks over the past several weeks is clear: Inflation is likely to recede well before the cycle turns, allowing the Fed to cut rates prior to an outright downturn.  Wilson’s skeptical, but said he’s not ruling anything out.

“The equity market appears to be focusing on the playbook from the last four cycles when cuts came to fruition with time left in the cycle,” he went on. “As discussed in our prior work, we believe the full breadth of earnings and macro data continues to suggest we are late-cycle [but] should the leading macro and earnings data change course and inflect higher, we would be open minded to the notion that a mid-cycle characterization would be more appropriate than a late-cycle one.”