AI Boom Squeezes Main Street

Stability in inflation expectations at 2.4% suggests that fiscal or inflation fears are not the primary drivers behind surging US long-term bond yields, according to Aidan Garrib, head of global macro strategy and research at PGM Global.

Inflation expectations remain stable at around 2.4%, and term premium data does not support a narrative of fiscal profligacy, indicating the rise in yields is not primarily driven by these factors.

Instead, the ACM model shows the 10-year risk-neutral rate closely tracking with Fed policy expectations, with the market pricing in additional rate hikes from the central bank.

The US economy demonstrates resilience, with the Federal Reserve tightening monetary policy into a period of economic strength, as evidenced by nominal GDP figures.

In contrast, Europe and the European Central Bank (ECB) appear caught in a cycle of forced policy mistakes, struggling with significant supply shortages and stagflationary pressures.

With credit growth remaining at 3%, current Treasury yields are inconsistent with a 3% Fed rate environment, indicating a need for higher rates.

This economic disparity means the market is recalibrating for a more hawkish stance from the Federal Reserve to align monetary policy with economic realities.

A significant portion of the reported capex is nominal rather than representing real economic expansion, as memory price increases and chip shortages absorb a large share of infrastructure budgets.

This higher nominal spending masks underlying issues in real GDP growth, contributing to nominal GDP printing at almost 7% without corresponding real economic gains.

Cutting rates directly could spike treasury yields and mortgage rates by increasing bond market volatility, exacerbating existing problems rather than solving them.

The Federal Reserve's proposed strategy is to use 'hawkish' talk to tighten policy and flatten the yield curve, aiming to lower borrowing costs for the real economy through a flatter long end of the curve.

This approach highlights the Fed's challenge in balancing AI-driven nominal growth with the struggling real economy, trying to restart demand for 30-year mortgage rates.

Federal Reserve interventions, such as those in August involving continued buybacks, often worsen inflation by sending equities and commodity markets higher.

This market management creates a "pushing on a string" scenario, where stimulus efforts designed to support equity markets and stimulate growth lead to contradictory outcomes.

The persistence of high inflation, ongoing geopolitical conflicts, and elevated commodity prices make it difficult for the Fed to effectively lower long-end yields.

Consequently, continued stimulus may inadvertently exacerbate the inflation problem, undermining efforts to stabilize and support the broader economy.

Corporate profit growth, particularly for companies like Google, is partly inflated by the mark-to-market accounting of AI investments, where revalued AI lab assets contribute to earnings per share (EPS).

Despite gains in the AI sector, consumer sentiment remains poor, and the housing sector is effectively paralyzed by high mortgage rates, indicating a disconnect between financial markets and broader economic well-being.

Outside of AI and the Magnificent 7 tech companies, there are effectively no job or stock market gains, indicating a highly concentrated economic expansion.

Policymakers have induced an 'AI-only' economy to avert a broad-based demand shock, as the overall economy faces significant capacity constraints.

If the broader Main Street economy were to heat up alongside current AI spending, interest rates could reach 10% due to capacity limits in power and commodities.

This scenario highlights that most sectors of the economy are in a recessionary state, with growth concentrated almost exclusively within the AI domain.

Aidan Garrib references BLS consumer expenditure survey data, arguing that the US economy is consumption-driven but heavily skewed toward the top deciles of wealthy households.

These wealthiest deciles account for a vastly disproportionate share of aggregate consumption, a fact often obscured by underreporting in surveys.

Because wealthy individuals rely more on asset prices than labor income, their consumption patterns are tied to stock market performance rather than traditional economic policy levers like interest rate hikes.

Comparing the S&P 500 in dollar terms versus gold terms reveals a stagnation in real value, suggesting that much of the perceived stock market growth is an illusion.

When adjusted for the debasement of the US dollar, stock market performance appears flat or even below 2008 levels, indicating that the dollar's declining value inflates nominal gains.

This debasement is suggested to be a deliberate path for policymakers to maintain the consumption loop and avoid fiscal rupture, rather than reflecting genuine economic expansion.

Financing-dependent consumers face an 11% reduction in housing purchasing power as the 30-year yield's ascent from 4.6% to 5.6% over the last six months drives mortgage costs higher.

This rapid increase in rates limits the purchasing power of consumers dependent on financing, effectively reducing their ability to afford a home.

Individuals relying on financing are now estimated to be able to afford roughly 11% less in housing volume or price compared to six months prior.

As pension plans see 10-year Treasury yields hit hurdle rates, they are shifting capital away from private equity to create the captive demand officials desire.

Institutions like pension plans are shifting away from private equity and private credit toward Treasuries as their funding status improves and 10-year Treasury yields meet their hurdle rates.

This strategy creates a consistent demand for US government bonds from various entities, including banks, pension plans, and stablecoin issuers.

Because full domestic reshoring would spark massive inflation, the U.S. strategy delegates hardware production to allies like Japan and South Korea to maintain AI leadership.

The US strategy focuses on maintaining leadership in AI while delegating hardware manufacturing to these key allies.

This approach aims to reduce dependency on China by "ripping the band-aid off," despite accepting short-term inflationary pressures.

Already, imported inflation is rising, with Korean semiconductors showing 12.6% year-over-year increases, indicating the immediate cost of this strategic realignment.

Europe's manufacturing sector is experiencing a significant hollowing out, evidenced by job cuts announced by major companies like Volkswagen and BMW.

Germany, in particular, faces a policy trap where it must balance maintaining zero deficit rules with the urgent need to boost industrial competitiveness.

This situation leaves the region's manufacturing base vulnerable under its current economic framework, struggling to adapt to global shifts.

Aidan Garrib warned that Europe risks strengthening right-wing political parties if it continues prioritizing the bond market over re-industrialization.

The current emphasis on inflation control and bond markets threatens the region's industrial base, potentially leading to a resurgence of right-wing political parties like the AfD in Germany.

Europe lacks the AI-driven economic growth and commodity independence observed in other major economies, putting it at a disadvantage.

Without a pivot, the region risks deepening economic decline and increasing political extremism, necessitating a fundamental change in economic priorities.

The rising support for the AfD in Germany is seen as a direct consequence of neglecting the economic well-being of the average person.

Aidan Garrib suggests this trend serves as a "shot across the bow" that policymakers can no longer ignore, highlighting the urgency of addressing economic grievances.

The disconnect between the European Commission's power consolidation and industrial decline creates electoral volatility, driving citizens toward extremist parties when their economic concerns are not met.