Deutsche Bank Says Markets Are Betting on a Perfect Outcome That History Says Doesn't Happen

Deutsche Bank macro strategist Henry Allen has a warning for anyone feeling good about the stock market right now: the setup doesn't add up.

In a research note dated August 17 and a follow-up appearance on Bloomberg's Bloomberg Brief, Allen laid out what he calls a fragile equilibrium. The S&P 500 is sitting at record highs. Credit spreads are tight. The Atlanta Fed's GDPNow model is projecting 5.8% annualized growth for the third quarter. Unemployment fell to 4.1% in July, a 13-month low, according to BigGo Finance's summary of Allen's report.

Inflation, however, isn't cooperating.

The Math Doesn't Work

June PCE inflation stood at 3.7%, according to BigGo Finance. Fed funds futures are pricing in only about 47 basis points of cumulative rate hikes through next June, according to the same report. Allen points out that historically, when inflation has run this hot, the Fed's first year of tightening has exceeded 100 basis points, citing the 2022 hiking cycle as the template.

"This goldilocks window isn't a sustainable equilibrium," Allen wrote, according to PrimeXBT.

The Bloomberg US Financial Conditions Index, a measure of how loose or tight money is across the economy, rose to its loosest level since 1997 last week, per BigGo Finance's account of the report (a separate account from PrimeXBT put the comparison at 1996). Loose financial conditions combined with above-target inflation and a Fed that markets expect to barely move is, in Allen's framing, a combination that doesn't have historical precedent for holding together.

Layer in energy. Brent crude has pulled back to around $88 a barrel but remains up more than 40% year-to-date, according to BigGo Finance, with the Strait of Hormuz still disrupted. Deutsche Bank argues equity and credit markets are pricing in resilient growth and contained oil prices, while rates markets are still pricing in the drag from geopolitical conflict. Allen calls that a clear divergence that can't persist indefinitely.

Two Ways This Breaks

Deutsche Bank, according to PrimeXBT, laid out two scenarios where the current pricing falls apart. First: growth stays hot and financial conditions keep loosening, forcing the Fed to hike more aggressively than the roughly one additional increase markets currently expect. Second: growth weakens on its own, which could undercut the conditions propping up stocks even without a recession. The bank pointed to the 2015-16 correction and the 2022 bear market as examples of slowdowns alone triggering major repricing, without a technical recession.

Either path is bad news for anyone holding assets priced for the good outcome only.

The Calendar Everyone's Watching

Two events this week will test Allen's thesis directly. The July PCE report, the Fed's preferred inflation gauge, is expected around August 26, with consensus forecasts pointing to 0.2% month-over-month core PCE growth, or 3.3% annually, according to Crypto Briefing's reporting on Allen's note. Headline PCE is forecast at 3.6% year-over-year.

A day or two later, Fed Chair Kevin Warsh speaks at the Jackson Hole Economic Policy Symposium, scheduled for August 27-28 according to most sources, though the Epoch Times listed the symposium running August 27-29. Jackson Hole has a track record of moving markets. Jerome Powell used the same podium in 2022 to deliver a blunt inflation-fighting message that sent stocks tumbling.

Gold Is Already Voting

While equity investors bet on Goldilocks, another market is telling a different story. Spot gold hit roughly $4,644 per ounce on August 24, its highest level since May 18, up from $4,603 on August 21, according to the Epoch Times. Gold has climbed more than 17% since bottoming near $3,959 on July 17.

Peter Schiff, chief economist at Euro Pacific Asset Management, put it bluntly in an August 21 post on X: "Gold is trading above $4,600. So far, over the first three weeks of August, gold is up 15 percent. This doesn't happen with a hawkish Fed determined to do whatever it takes to lower inflation. It happens when investors realize the Fed is bluffing and intends to let inflation run away."

That's Schiff's read, and it's an aggressive one. ING Bank commodities strategist Ewa Manthey offered a more measured take in an August 21 note, saying gold's rebound is real but "unlikely to be straightforward" given persistent inflation and the possibility the Fed raises rates further. ING is forecasting fourth-quarter gold prices averaging $4,150 an ounce, well below current levels, on the assumption that monetary policy stays restrictive.

A World Gold Council survey found 89% of central banks expect global gold reserves to grow over the next year, with a record 45% planning to add to their own holdings, according to Fox News. World Gold Council strategist Joe Cavatoni said central banks are diversifying away from reliance on U.S. Treasuries because gold "provides liquidity, diversification and protection against inflation and geopolitical uncertainty."

None of this proves the stock market is wrong. Strong GDP growth and low unemployment are real, not fabricated. But Allen's argument is narrower than a recession call: he's saying the specific combination priced into markets right now, hot growth, low inflation, minimal Fed action, has rarely all shown up together historically, and gold's surge suggests a meaningful slice of the market is already hedging against that combination breaking.

The next 72 hours will start to answer which market has it right.