The US macro narrative’s shifting. Fast.

As discussed at some length Monday in “Traders Rush To Hedge Stock Crash Amid ‘Trump 2.0’ Policy Jitters,” the near-term implications of the “Trump 2.0” policy mix for the world’s largest economy are coming into view, and the outlook, while perhaps not dour, isn’t auspicious either.

As it turns out, setting fire to federal government payrolls (i.e., engineering a “government recession“) isn’t necessarily conducive to good macro vibes, nor likely to goodwill among the impacted, and the same’s generally true of deliberately undermining the economic and geopolitical fortunes of America’s closest allies. It’s just bad karma. A whole lot of bad karma.

US growth expectations are receding meaningfully already, and although GDP tracking’s holding above 2% on the Atlanta Fed’s popular model, the flash read on S&P Global’s US services PMI for February tipped just a 0.6% annualized expansion for the current quarter. That’d be the slowest since the recession that wasn’t in Q2 2022.

Stocks aren’t lovin’ it, and indeed, the rates-equity correlation just flipped back into positive territory for the first time in two and a half months, as illustrated by the figure below.

What does that mean, exactly? Colloquially, it means bad news is just bad news (i.e., bond rallies triggered by growth jitters are accompanied by lower stocks, reflecting the same growth concerns).

“10-year yield[s] [have] fallen below 4.50%, and yet [the] ~6,100 resistance level [for the S&P] has continued to hold back the index,” Morgan Stanley’s Mike Wilson wrote Monday. “We think this… is due to the reason why rates are falling — softer growth prospects alongside limited progress on inflation which is preventing the Fed from cutting more aggressively than assumed just a few months ago.”

There you go. Bad news is just bad news on the growth front, and at the same time, the Fed’s hands are tied with core inflation loitering well above 2% and the most important measure of longer run household inflation expectations newly perched at the highest levels since 1995.

What do you get when growth deteriorates and inflation’s stubborn? You get stagflation for one thing, but you might also get a deeper downturn because the central bank can’t cut rates as deeply as they otherwise might if price growth was slower.

Wilson went on to suggest the increase in yields from late-September to mid-January’s catching up to the economy and to risk assets on a lag.

The figure above, which is pixelated even by Wilson’s high standards for blurry charts, plots the US economic surprise index (in yellow) with benchmark yields inverted, and on a 60-day lag (in blue).

But it’s not just last year’s rate rise that’s impacting growth outcomes and sentiment. It’s also the policy mix.

“The immediate policy changes from the new administration (immigration enforcement and tariffs) are likely to weigh on growth while providing little relief on inflation,” Wilson wrote, adding that “DOGE is off to an aggressive start and this is also likely a headwind to growth initially, as federal spending and headcount is reduced.”