Viewpoint

November 15, 2024 | 14:43

November 15, 2024

Economist

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Priscilla Thiagamoorthy

Senior Economist and Vice President
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Scott Anderson , Ph.D.

Chief U.S. Economist and Managing Director
Economics

Scott Anderson is BMO’s Chief U.S. Economist and Managing Director. He analyzes and forecasts U.S. national and ... (Read more)

Priscilla Thiagamoorthy

Senior Economist and Vice President
Economics

Priscilla joined BMO Capital Markets in 2016 and plays a key role in analyzing Canadian household trends and the... (Read more)

Our Thoughts

The Goldilocks ‘Soft Landing’ May Never Arrive

Wall Street isn’t waiting around to see how this movie turns out. It’s already in motion trying to find a new equilibrium, gaming out recently resilient economic growth (the economic surprise index has turned the most positive since February), a Fed that will probably be more reluctant to cut interest rates next year, and a President intent on raising tariffs on all trading partners. In turn, consumer inflation probably doesn’t quite reach the Fed’s target; and even if it does for a month or two, it won’t be able to stay there for very long. We are rapidly moving from the era of the Goldilocks soft landing consensus on Wall Street toward splitting into two camps: the ‘no landing’ crowd and the ‘buckle your seatbelts, bumpy landing’ crowd… What did Monty Python often say? “And now for something completely different.”

The ‘no landing’ crowd is single-mindedly focused on the glass-half-full analysis centered around corporate and individual tax cuts and industry deregulation. Forecasts of a stronger dollar, higher interest rates, and higher inflation just aren’t penetrating this gravy train to Nirvana. This market view is illustrated by equities; the CBOE VIX index sank this week to as low as 14.0 from an above-trend 23.2 at the end of October, its lowest daily level since mid-July (Chart 1). The S&P 500 gained another 5.0% since the election at one point this week and has risen more than 70% from pre-pandemic levels. The Cyclically Adjusted Price-Earnings (CAPE) Ratio hit 38.18 on Wednesday, just shy of the equity valuation peaks hit in 2000 and November 2021 and more than double the historical average P/E of 17.5 (going all the way back to the 1800s; Chart 2). Priced for perfection indeed; what could possibly go wrong?

The Treasury market is giving off totally different vibes, factoring in a bumpier landing for the Fed, inflation, and the U.S. economy. The fed funds futures market is now pricing in only a 62% chance of a quarter-point rate cut in December, and not quite three quarter-point cuts by the end of next year. Treasury yield curve inversion has nearly disappeared in just one month (Chart 3). The 10-year yield has risen around 80 basis points since late September even as the Fed has sliced 75 bps off of the fed funds rate. About two-thirds of the increase (50 basis points) has come from rising real yields as investors have grown more skeptical of the Fed’s Dot-Plot rate guidance, while one-third or 30 basis points has come from rising inflation break-evens.

Just two months ago, the bond market thought inflation over the next five years would be closer to 1.9%; on Thursday, the inflation expectation was a whopping 2.4%, a view that now holds all the way out the curve to the 20-year maturity. The Fed’s ability to sustainably achieve its 2% inflation target is being questioned under this new fiscal policy environment. Moreover, the U.S. trade-weighted dollar has appreciated more than 5% since the end of September. All signs that the bond market and foreign exchange markets are taking Trump’s tariff threats seriously and positioning their portfolios accordingly. Rising interest rates and higher tariffs are both likely to slow U.S. GDP and employment growth, putting corporate profits and the stock market rally at risk.

Wall Street is currently as divided on the economic and inflation outlook as the electorate was on Election Day. Perhaps the Goldilocks ‘soft landing’ was just a fairy tale after all.