Margin matters… and depending on what type of margin you're referencing, it can mean different things to different people For instance, to a student, it may mean squeezing the margins on a mid-term paper to hit that 12-page requirement. To a fantasy football coach, it’s the margin of points keeping you from rage-dropping your entire bench after your kicker turned out to be the highest scorer on your team. To a trader, it’s the thin spread between high-fives or ramen dinners. To your grandma, it’s the edge of the coupon she cut out back in 1987 that she swears is still valid.
This week, we got a solid look at our inflationary landscape. On Wednesday, the PPI came in lower than expected, which helped reinforce the recent rally. However, one key data point that raised questions was the continuation of the current Goldilocks trade environment. To unpack that: both stocks and bonds have been improving in tandem (which is typically not the case, as what benefits one doesn’t necessarily benefit the other). This has been driven from the notion that at the end of the day, the Fed is cutting rates, and we are moving away from tighter conditions to a more accommodative one. Win/Win for both stocks and bonds… But not so fast, recognizing the employment landscape has been deteriorating, there comes a point that the correlation breaks down… and that brings us back to PPI, specifically in the segment of profit margins.
The S&P continues to climb due to record high earnings expectations. Much of this has been driven by AI, but steady consumption demand has also justified the multiples being applied. However, recent data shows margins are starting to come under pressure. Although tariffs haven’t been as disruptive as initially feared, today’s CPI release showed core goods posting their largest percentage increase since May. This is beginning to strain businesses, which will likely pass those costs on to consumers.
Given the current employment landscape, what’s realistic for consumers to absorb? If higher prices lead to lower consumption due to demand destruction, then earnings will take a hit, disrupting the delicate win-win environment we’ve seen. Take a look at the chart showing the declining correlation.
I share all this to highlight a phenomenon we’ve been missing for some time: flight to quality. Typically, when the stock market looks shaky, investors sell and move their money into safer assets like bonds, which in turn helps the bond market (and mortgage rates). What we should be watching for is continued capitulation in the jobs sector, leading to demand erosion and, ultimately, lower earnings.
Today, recession isn’t being priced in, and that’s assuming the Fed has everything under control. Yet, it doesn’t take much imagination to see how quickly things can shift, especially with already a weaking labor market. We’ve seen constructive moves in Treasuries, but there’s still plenty of risk out there—particularly in equities. A safety trade could help our cause and potentially drive rates even lower.
So, whether you’re watching rate spreads, clipping coupons, or just hoping your fantasy team stays healthy… with a flurry of recent rate improvements, here’s to upgrading from ramen to steak dinner soon enough!
10yr: We closed right above 4.0%... Still some work to do to break through!