Rising rates don’t halt bull markets but real yields exceeding the economy’s potential long-run growth rate could. That relative level could lead to a stock-bond collision if it persisted long enough to slow the economy.
The Fed hiked rates last week, but Fed officials expect this tightening cycle will involve no more than three 25-basis point hikes, contingent on inflation coming down quickly in 2027. We’re inclined to agree.
Labor supply is not meaningfully boosting inflation today, but the net exit of unauthorized immigrants has lowered the bar for stronger labor demand to turn inflationary. Hawkish monetary policy surprises over the coming year are possible.
Concerns by the major AI companies that they are locked into a financially unsustainable arms race for AI dominance are likely playing as much a role in their newfound “go slow” approach as concerns over AI doom.
Scott Bessent’s attempts to suppress yields while financing large twin deficits risk crashing foreign inflows, the dollar, US bonds, and equities. Without a major equity selloff or large-scale commercial bank purchases of Treasurys, the bond selloff will persist – producing a major equity drawdown and a lower dollar.
Concerns about the savings rate’s sustainability ease after adjusting for retirements and capital gains. The US economy continues to grow at a pace that is neither too hot nor too cold and investors should remain fully invested in risk assets.
An acute shortage of AI hardware will support tech stocks into year-end. However, AI companies may need to ultimately generate $10 trillion per year in revenue to justify their capex. Barring a massive increase in productivity growth, this will be very difficult to achieve. Despite today’s Treasury announcement of upsized buyback operations, bond yields are likely to remain elevated over the coming months. Rising crack spreads have reduced the demand for crude, which is not encouraging for global growth. On the FX front, recent intervention to support the yen will probably be insufficient, but there is significant long-term upside for the currency.
As long as the AI boom keeps booming, all other investment considerations will remain on the back burner. However, if the AI trade fizzles, this would expose deep-seated problems within the global economy, which could very well lead to an economic downturn as early as next year.
