Macro

Markets Ignore Risks, Bet on Growth with CPI to Drop to 2.5%

Markets overlook recession and inflation risks, betting on 'immaculate acceleration' amid economic dissonance.

By Bill Bullington

5/16, 04:38 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
article-main-img

Key Takeaway

  • Markets are dismissing recession and inflation risks, betting on "immaculate acceleration" with growth forecasts up to 2.4% for 2024 and CPI expected to drop to 2.5%.
  • Despite economic signals of potential downturns, such as weak ISM data and rising unemployment levels, market volatility remains unusually low.
  • Commodity prices like copper, cocoa, and natural gas have surged 30-50%, yet overall market complacency keeps portfolio hedging costs low.

Market Dissonance Peaks

The current financial landscape is marked by a stark dissonance between economic indicators and market behavior. Despite clear signs of a volatile, potentially recessionary period ahead, markets are largely ignoring the twin tail risks of a downturn and resurgent inflation. Instead, an "immaculate acceleration" scenario, characterized by booming growth and benign price appreciation, is becoming the base case among investors. This divergence is notable, as it comes at a time when economic signals suggest a more somber outlook and persistent price pressures.

Immaculate Acceleration: A Risky Bet

The concept of immaculate acceleration, which entails accelerating growth alongside slowing inflation, is being priced into markets despite its near-impossibility. This is evidenced by nominal rate volatility picking up, suggesting anticipation of a positive growth shock, while real rate volatility declines, indicating expectations of continued inflationary easing. Such a scenario represents a significant gamble by the markets, essentially betting on having their cake and eating it too, amidst signs that the economy may not support such optimism.

Equity and Bond Markets: Complacency at Play

Equity markets have shown an unusual degree of nonchalance, rallying on the belief that the Federal Reserve would cut rates aggressively if a recession loomed. This rally persists even as the rates market no longer prices in such tail risks, indicating a level of complacency not previously seen. Similarly, bond volatility remains low despite high and rising inflation volatility in the US and Europe, suggesting that bond markets are also overlooking significant economic signals.

Commodities and Hedging: Signs of Caution

While overall market volatility is muted, there are signs of caution in specific sectors. Commodities such as copper, cocoa, and natural gas have seen price surges and increased volatility, indicating some market participants are hedging against potential economic shifts. Additionally, the low implied volatility across markets has made portfolio hedging costs relatively cheap, offering a prudent path for investors wary of the ignored twin tail risks of inflation and recession.