Of all the purportedly puzzling dynamics bedeviling market participants in their belabored efforts to makes sense of things in 2024, the most vexing may well be the decoupling of equities and rate-cut pricing.

I’ve obviously spent quite a lot of time on the subject in recent weeks. Like this year’s other key macro/market debates, there are a couple of “easy” explanations which’ll work if you’re not especially interested in the nuance. But most readers are interested in the nuance. Otherwise you wouldn’t be here.

You’re all familiar with the chart, but I’ll refresh it anyway. The figure below shows market-implied rate cuts for this year with the S&P.

You can make a similar chart with the benchmark’s forward multiple: Stocks re-rated in lockstep with more aggressive rate-cut pricing during November and December, but the two (multiples and implied 2024 Fed cuts) went their separate ways beginning in late January (there’s more on that here).

The simplest explanation is this one: Rate-cut pricing is less than half what it was at the extremes because the US economy continues to outperform expectations and that’s a good thing, particularly when you consider the Fed’s still going to cut this year, just maybe not as much. For the umpteenth time, a sturdy economy plus rate cuts is the best possible scenario and it’s fair to suggest it’s now consensus.

That explanation has a lot of explanatory power (hat tip William of Ockham), but it doesn’t tell the whole story. In a Thursday note recapping some of the main points from what I described as his “unified theory of everything,” Nomura’s Charlie McElligott walked through what, in his view, accounts for the sharp divergence between fading rate-cut expectations and buoyant equities beyond the simple explanation mentioned above.

Below, find a heavily abridged, edited version of McElligott’s take, presented in the bullet point format he frequently employs in his original notes.

• [There’s the] bullish market perception of recent Waller / Powell commentary regarding [a] shared desire to adjust Fed balance sheet holdings towards shorter maturities occurring at a time when Janet Yellen’s Treasury has scrapped prior convention and is refunding majority in T-Bills vs Coupon. In the eyes of ‘Mr. Market’ [that] looks like “priming the pump” for a future state of “debt monetization–lite” which risk assets love.
• A more permanent and aggressive use of fiscal deficits and stimulative policies in the post-COVID world from governments and politicians [has] major stimulative implications for growth, inflation and market- / policy- volatility.
• [T]he opportunistically-timed ISDA letter requesting SLR reforms which would exclude on balance-sheet US Treasurys from the total leverage exposure calculation [would free banks to] act as the private-sector solution to finance the surge in Treasury issuance from [a] permanently higher state of fiscal deficit spending, and acts as a de facto “QE surrogate.”
• The generational secular phenomenon that is AI and its halo effect [along with] higher earnings revisions [has] implications for index heavyweights, with sales, EPS and guidance destroying prior expectations and resetting higher [almost] quarterly.
• US corporates and households [have] traded the ZIRP policy beautifully, terming-out debt, refi’ing mortgages and taking out HELOCs at impossibly low rates and cleaning up balance sheets, which has allowed many to absorb higher rates with barely [any] issue.
• And all of this with the broad economy looking exceptionally “Goldilocks,” meaning that, hey, maybe the market is taking “high for longer rates” not as an indicator of increased recession potentials, but instead as a move back to levels consistence with economic expansion.

So, that’s Charlie’s take, again edited and abridged.

The big test comes in the March SEP refresh. Thursday’s PPI data made it incrementally more likely that the new dot plot will reflect just two cuts in 2024 versus three in December.

If that risk is realized (likely alongside a higher year-end core PCE projection) it’ll be a new challenge for elevated equity multiples and risk assets more generally.