The stock market has enjoyed a “goldilocks” moment recently, a scenario where inflation and interest rates drop without triggering a plummet in economic growth.
But that fairy tale state appears to be fading away, and the economy could be in for a dose of reality.
The recent goldilocks phase comes as inflation declines—implying that the Federal Reserve can soon stop increasing interest rates. Meanwhile, the US economy, while growing at a slower pace, seems to be holding up.
Markets have responded in kind. the
is up to start the year, and it has gained about 11% since its 2022 low, hit in October. Alongside that move, Treasury yields across the board have dropped. It is a perfect environment for stocks—rates and inflation are falling, but the economy is still on strong footing.
Falling inflation and a strong labor market “don’t get more Goldilocks than that,” wrote Bank of America strategists.
At the same time, several factors signal “peak Goldilocks,” the strategists wrote.
First off, the Fed could still signal more rate hikes than expected. Consumer inflation is still running at over 6% year over year, far from the Fed’s 2% target, so the central bank may have more work to do. If the Fed signals more increases on top of the last few anticipated, yields would rise and stocks would fall.
Secondly, economic growth and profit forecasts may not have bottomed yet. Higher rates hurt the economy with a delay—and falling inflation means companies would lift prices by a lesser degree, while the waning demand could also lower the number of goods and services sold. Lower earnings estimates from analysts could be on the way.
Perhaps that’s why the stock market slid on Tuesday, and looks set to drop again on Wednesday. S&P 500 futures have fallen 0.9%, while
Dow Jones Industrial Average
futures have declined 0.8%, and
futures have dropped 1%.
The stock market yearns for tame inflation and strong economic growth. The world probably hasn’t gotten there yet.
Write to Jacob Sonenshine at firstname.lastname@example.org