Until the US labor market turns — and that’s assuming the Trump administration lets it turn — risk assets are the place to be, particularly with US monetary policy set to inflect decisively dovish.
That was the message on Wednesday from Nomura’s Charlie McElligott, who reminded market participants that we’re still living in a “high nominal growth world.” That’s auspicious for corporate earnings.
“Core CPI is 3.1% and rising, average hourly earnings are at 3.9% and rising and 401(k)s are booming, contributing to a positive wealth effect impulse [which] eases financial conditions, further stimulating excess demand,” McElligott wrote. “So the irony is that ‘not-as-bad-as-we-feared’ goods inflation perversely allows for Fed easing into a backdrop where nominal GDP’s already running 5-6%.”
In other words, the absence of tariff pass-through to goods prices may ultimately raise the odds that overall inflation picks back up given the read-through of Fed cuts for services price formation in a services-driven economy.
The figures above, from McElligott’s latest, show you how SOFR-implied rate cut odds have shifted. In a word: Dovishly. They’ve shifted dovishly, and meaningfully so. The implied odds of three 2025 cuts have doubled over the last month and tripled since May.
Time will tell if the services inflation uptick from the July CPI release is a blip (Scott Bessent called it “very odd”), but if it sticks around it’ll be tragicomic: “The punchline” is that the benign read on goods prices “only further embeds ‘inflation overshoot’ in the forwards,” McElligott wrote, referencing the read-through of Fed easing for services price growth expectations.
The good news for risk assets is that “stocks will keep working in a virtuous environment for corporate earnings, especially as equities clearly now view the Fed as unserious on inflation and asymmetrically-tilted towards preemptive easing yet again,” Charlie went on. A Fed that cuts aggressively now, he said, “is simply signaling markets to press speculation in risk asset longs.”
On Wednesday, CNBC said Donald Trump’s now considering David Zervos, whose strategy notes can quite fairly be described as enthusiastic cheerleading for Trump’s brand of economic nationalism, for Fed Chair.
“The good news for risk assets is that “stocks will keep working in a virtuous environment for corporate earnings’
As you and fellow readers may have deduced, I am Max McElligott. But this one has me scratching my head. I’m guessing that he is drawing a 401K wealth effect line to higher consumer spending? JL may correct me, but I recall that consumer discretionary stocks have been relative laggards this year so that may help the market to broaden out further.
Otherwise, how much would further risk on really help earnings? And who cares?? In this environment earnings don’t matter. Nor do valuations and other “fundamentals”. As our dear Leader reminded us yesterday, this is a closed self-perpetuating wealth building machine.