The Dog That Didn't Bite

The FOMC and economists spent '25 worried tariffs would cause faster inflation, instead the three adverse aggregate demand shocks caused disinflation that is likely to persist in '26.

This week’s note discusses inflation, the earnings outlook and includes a special contribution on equity and index implied volatility, and the impact on implied correlation as it pertains to earnings season, from Dean Curnutt, the CEO of Macro Risk Advisors.

• Inflation stayed surprisingly stable despite tariffs, as weak pricing power, slower fiscal spending growth, and deflationary pressure from China offset tariff effects; goods prices are flat-to-falling, housing inflation is easing, and services inflation closely tracks government spending rather than monetary policy credibility.

• Fiscal policy—not the Fed—is the key driver of inflation cycles, with past inflation episodes tied to government spending and transfers; recent moderation in spending growth has cooled services inflation, though sustainability is questioned due to mandatory spending pressures.

• Markets are relaxed about inflation but wary on rates, with stable breakevens, low bond volatility, and 10-year yields range-bound; downside breaks likely require recession, while upside risks stem from stronger growth, delayed Fed cuts, and AI-driven investment pushing real rates higher.

• Corporate earnings and markets show tariff margin pressure and dispersion, with consumer sectors absorbing costs, banks dependent on regulatory relief, and unusually low implied correlation during earnings season—suggesting stock-specific risk is priced, but systemic spillovers are underappreciated.