The Fed's Balancing Act in Inflation & Jobs Meets Accelerating AI Demand

SPEAKER_1 (0:00)

Stephen Kates, Economist, Clock Tower Financial, and Jed Ellerbroek, Portfolio Manager, Argent Capital Management. Both with us right now. So, Jed, I'll start with you. Some of your thoughts here, it looks like we're getting a lot of the same, and that they are still leaning towards a rate hike, and more concerned about inflation than they are about jobs.

Jed Ellerbroek (0:21)

Yeah, I think so. I think it's a hawkish Fed that's caught between competing objectives. The election's coming up soon, they don't really want to hike before that. They're concerned that inflation is too high, oil prices are too high, and they also want to stop giving forward guidance. But the minute they stopped a couple months ago, rates started rocketing higher, and last week they had to come out and have a couple key members of the FOMC kind of calm the market down and talk it down. So, kind of scrambling, it seems to me.

SPEAKER_1 (0:49)

And some of the Fed members actually thought that inflation risks were becoming a little more skewed in recent months, and so that's another reason to sort of stay on the team of hiking. What say you here, Stephen?

Stephen Kates (1:06)

They knew at that point, the hike, clearly a unanimous decision, was, seemed to be the right move. After the adjustment that the Bureau of Economic Analysis made to the inflation numbers, I think that the Fed may have gotten a little bit over their skis in terms of what they expected. So I think October at this point, both because it's ahead of the election and because those inflation numbers did come in lower than what the Fed expected, there's little likelihood that we'll see a hike in October. And I think that the market might be a little bit over-indexed on what they expect in December.

SPEAKER_1 (1:45)

What did the Fed auction, we just had the auction, the Treasury auction, actually, 39 billion. I want to ask this to you, because you're an economist, I didn't know what you thought of this, Stephen. But we had 39 billion in 10-year bonds sold at 5.3%. That was the highest since November of 2000 And we did see the 10-year bond yield come down after that auction.

That's something they may talk about too, right? What does it mean?

Stephen Kates (2:12)

Well, I think that, as Jed referred to, the market is filling in the gap left by the Fed. We're not getting forward guidance. And so the market and yields are reflecting what they expect may be necessary. I think a variety of things, whether it's AI, whether it's simply the totality of US debt and the geopolitical situation, it's being reflected in these high yields on the long end. And for now, that doesn't seem to be constraining the economy too much.

But it's something that for the consumer, especially in the mortgage market, is certainly a big deal.

SPEAKER_1 (2:49)

And when you mention AI, I'm glad you thought about that. We think about the AI build out. There was talk how much AI is contributing to GDP. Also, that the AI build out could cause aggregate demand to outpace supply over the medium turn, putting pressure upwards on inflation. So the idea was that AI was supposed to help in productivity, bring down inflation, but maybe in the near term, it won't. What did you think? Anything about the AI comments at all? First of all, it's unusual to hear the Federal Open Market Committee talking about AI. What are your thoughts?

Jed Ellerbroek (3:18)

Yeah, the AI build out, the datacenter build out, has led to a ton of credit issuance this year. And I think that's probably had some impact on yields. You see the news overnight in the FT about SpaceX, issuing $40 billion in incremental debt. The CDS spreads on SpaceX went up quite a bit today. So the market's a little bit skittish about that. We have a lot of supply.

We have a strong economy and inflation is too high. Like you said, the AI build out is definitely inflationary in the near term. Let's look at the cost of all the iPhones we're going to buy here over the next year. The price has gone up quite a bit.

SPEAKER_1 (3:52)

I also think about some of the warnings that we've been hearing about AI. Ray Dalio came out with that, a few others.

It's so heavily weighted in the S&P and the NASDAQ. All things AI, we're depending on it a lot. As you noted, even in the private markets, in the credit markets now, it was some cyclical funding that was happening. Now they're going outside. We had the consortium of the six banks that went to invest. There's a lot going on now. There's a lot of money on the line. How do you feel about that?