AI Is Propping Up the Economy. The Fed Could Break It.

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Andrew Sarna (1:26)

We're in this new regime, like the old rules don't apply. It's actually really just the AI economy driving the broader economy. You have pressure building in these various pockets, but you don't know where the leak is going to spring. Yields are rising, inflation is rising. And guess what? There really is nowhere to hide.

Maggie Lake (1:49)

Hey, Andrew, it's great to see you again.

Andrew Sarna (1:51)

Hi, Maggie. Thanks for having me back.

Maggie Lake (1:53)

So there's a lot to discuss. Let's talk about something that that Trump administration does think they have some influence over, which is the Fed. I think part of what's pressuring yields right now is that everyone seems to think the Fed is going to need to hike three or four times to rein in inflation. The Fed's been sounding pretty hawkish. Do bond investors have it right? Are we looking like we're embarking on some kind of more aggressive tightening cycle?

Andrew Sarna (2:17)

Yeah, I was honestly surprised to see the first hike happen.

Because if you approach it from a logical perspective, rather than just looking at the components of CPI, it's not like a hike is going to print any more oil. And that's ultimately what is driving inflation higher, which had obviously influenced the Fed. Now, I'm a little bit worried about, you know what? When we actually look at the economy, yes, there are green shoots, and it does look fairly strong. There are signs that the economy is in decent shape. But at the same time, once you look under the covers, it's actually really just the AI economy driving the broader economy. If you look at some of the cyclical sectors like housing, well, it was already in pretty poor shape, and now we're seeing yields that are only going to pressure that sector even harder. And then on the manufacturing side, if we look at other cyclical sectors, I think that's a little bit more idiosyncratic because you have these initiatives to reshore manufacturing.

I worry about the situation where we end up in this over tightening scenario.

Because as I mentioned, the broader economy is sort of lukewarm right now, and it's really only the AI economy that is running red hot. It's that I heard recently that I thought was pretty interesting, is meta alone is going to spend more on AI capex this year than every other country in the world's defense budget other than the US. So I think that helps investors contextualize just how much money is being spent there. And we're going to run into this situation where an over tightening causes the broader lukewarm economy to actually slow. And then if we see any hiccup on the AI side, well, the economy is going to be in a pretty bad place. And I could see a situation where we get that growth scare. But at the same time, you want that seems to be actually the only way out. We know Basant wants to see Treasury or the 10-year Yale back to 3 percent. And I don't see, unless we get peace in the Middle East, I mean, a slowing economy is really the only way to get yields under control.