Hello, and welcome back to another episode of blue Chip. Now you have Daniel Du, CNN chief investment officer, and Vince Parekh, investment. So today our conversation will be fairly heavily centered on the more big picture macro, including interest rates, oil, some foreign relations type stuff, as opposed to some of the more seemingly exciting things like equity market volatility.
00;01;42;16 – 00;02;07;28 Unknown But nonetheless, what’s driving markets right now is very heavily centered on the macro. So I think that’s a great place to start. Number one first topic, some bubbling up between the US and Canada, specifically the trade relationship between the two parties taking a bit of a turn for the worse. So, recently we had some negotiations between the US and Canada somewhat collapsing.
00;02;08;00 – 00;02;32;09 Unknown So the US has come out and imposed a 50% tariffs on roughly $20 billion worth of Canadian goods. As a result, Canada came back and basically prepared dollar for dollar retaliation. So I would say 20 billion sounds like a big number. But if you look at that figure, relative to the entire North American economy, it’s not the biggest economic shockwave, that I think we could have seen.
00;02;32;12 – 00;02;59;09 Unknown And so keep in mind the the amount of goods that flow between the two countries is pretty isolated into certain segments. But what I think it is a reminder of is, is that there are certain things bubbling up underneath the hood that the markets are going to have to start pricing in. So this year at least, the focus on things like this has been really around the US and Iran conflict in the Middle East.
00;02;59;11 – 00;03;27;17 Unknown If you have the tariff tantrum start to rear its head again, I think that’s going to add an additional layer of uncertainty. And investors don’t like uncertainty. So regardless of what the actual market reaction was, and it was fairly centered around just foreign exchange stuff, I think to me it’s more of just the reminder that trade policy is working its way back into the equation specific to inflation, which will, you know, also talk about.
00;03;27;24 – 00;03;51;12 Unknown And that’s kind of a bigger piece to the overall interest rate puzzle. Yeah. You know I would agree with that. I think it’s you know, we’re dealing with multiple things at once that are impacting the inflation story. So certainly something that is not ideal for markets right now. But, you know, also still a pretty fluid, situation where we could see things go back and forth a bit.
00;03;51;15 – 00;04;11;17 Unknown Yeah. And again, you know, this isn’t the the focal point of financial markets right now, but you do kind of see it bubbling up a little bit. And so for example, if you were to get let’s call it an immediate unexpected resolution to the conflict that’s been ongoing in the Middle East, all of a sudden the market will turn its focus to something like this.
00;04;11;19 – 00;04;33;01 Unknown I think that’s a good segue to the second topic here. And that’s specific to oil prices and inflation. So, this has been a topic this year. This year oil’s been all over the place. If we look at just the most recent two weeks, crude prices have reacted to some of the developments between the US and Iran, or lack thereof.
00;04;33;07 – 00;05;01;13 Unknown So, last week, I guess technically that would be August 18th. We had Brant Crude climbing to its highest level in more than three weeks. And that’s directly a result of some of the optimism around negotiations between us and Iran starting to dissipate. And here’s really why the whole oil conversation matters so much right now. Higher oil prices, as we’ve talked about on this podcast and elsewhere, a blue chip, that doesn’t just mean more expensive gasoline.
00;05;01;20 – 00;05;22;21 Unknown There is this domino effect that happens as you get higher prices per barrel of oil that include trickling down to transportation costs, manufacturing costs, and eventually consumer prices. And also, I would say the kind of final leg is that consumers can start to shift spending elsewhere if they’re spending more on what it costs to fill up their, their cars.
00;05;22;23 – 00;05;55;10 Unknown It also has an impact on the Federal Reserve because as we we know, you know, energy prices have been a big contributor to inflation dynamics this year and this this continued tug of war between the two countries has made the Fed’s job a lot harder in its efforts to tamp down inflation. So you have had some of the more isolated Federal Reserve bodies highlighting this broader shift, arguing that financial markets are increasingly pricing supply side, supply side shocks as a pretty big economic risk.
00;05;55;10 – 00;06;19;15 Unknown So unfortunately, right now it’s like we don’t really have a lot of Intel to go off of the the negotiations that exist between the US and Iran at this point are almost pure hearsay. So there’s not a lot of ability to kind of map out what the US economy and thus inflation really look like over the next six months.
00;06;19;17 – 00;06;44;16 Unknown And keep in mind this can change on a dime. Just as we saw at various points throughout this year with regards to the talks between us and Iran, but right now it just doesn’t seem like we’re making progress. It feels like we’re in a bit of a stalemate, and although we haven’t necessarily seen it rear its head in terms of dramatically higher year over year inflation figures in recent months, it’s still looming underneath the surface.
00;06;44;19 – 00;07;05;22 Unknown Yeah. You know, to kind of add on to what you mentioned about it being driven by supply side shocks thing, that’s really important because inflation can be driven by, you know, various different things, whether it’s supply side shocks or the traditional demand driven boom. So on the supply side, shock side, it’s more difficult for the fed to combat those rising prices through interest rate hikes.
00;07;05;22 – 00;07;31;16 Unknown Whereas, you know, they can’t particularly, you know, pull back spending by hiking and dampening economic activity on that side. So, yeah, you know, it is certainly a much more challenging thing for them to combat relative to just that, you know, traditional demand driven boom, of inflation. But, yeah. So yeah. So overall challenging environment. Yeah. Well let’s, let’s stick on the Federal Reserve for next topic.
00;07;31;19 – 00;07;54;20 Unknown So the Federal Reserve as we kind of perceive them today. Well, actually, let me take a step back. Coming into this year, I believe there was expectations for two rate cuts throughout the year. At some point, if you look at the end of June, there was then expectations actually for two rate hikes over the following year. And that push and pull continues to change.
00;07;54;23 – 00;08;25;26 Unknown So right now I would say I think Vince we have fed funds, futures markets are pricing, a 25 basis point rate hike by December January. Okay. So this continues to move around. And the most recent larger development came last week on Wednesday when we had the minutes from the Federal Reserve’s July meeting come out. And basically what it indicated is that some of the policymakers were more concerned about inflation than investors had previously thought.
00;08;25;28 – 00;08;48;23 Unknown So we did already know that three fed officials voted for a rate increase at that meeting. That didn’t happen. Wasn’t a majority. There were those three dissenters. But, the commentary that was released last week does indicate there are more than just those three individuals that are somewhat leaning towards I would I would say immediate rate hikes.
00;08;48;26 – 00;09;31;12 Unknown So right now, to me, the idea that the federal Reserve is under the gun to move, I think is not true. And this is just opinion. You’re getting conflicting pieces of evidence. So yes, the longer that the conflict in the Middle East exists, the more impetus there might be for the Federal Reserve to hike interest rates. At the same time over the last couple of weeks, trying to put the whole piece to get pieces of the puzzle together, you’re getting conflicting evidence, whether it’s from the labor market where we’ve seen some escalating weakness or retail spending, consumer spending, which is roughly two thirds of the US economy, getting some red flags, getting thrown
00;09;31;12 – 00;09;51;12 Unknown up there. So how can you start to think about hiking interest rates when you’re getting broad based economic weakness domestically? I’m not ready to sit here and say that that’s the case, but I think the ideology behind that makes this move for the Federal Reserve a lot more complicated to anticipate. The last thing I would say is that we will get some additional Intel in the very near future.
00;09;51;12 – 00;10;15;21 Unknown With Fed Chair Kevin Warsh scheduled to speak at the Jackson Hole Economic Policy Symposium. This is always a kind of flagship event for the chairman of the Federal Reserve to kind of step back and speak about underlying economic policy and current thoughts. So that will be very closely watched. And I think right now, investors are all wrestling with the same question.
00;10;15;23 – 00;10;36;24 Unknown What’s more important right now, actually making sure the US economy is chugging along at an appropriate pace or starting to constrain rates because we’re seeing elevated inflation figures. Yep. I completely agree with that. And I think, you know, what we see right now is a very reactive market. So as you outlined with the fed, we’re speaking at Jackson Hole.
00;10;37;01 – 00;10;56;10 Unknown We’re gonna see the markets certainly react to that. And then just ongoing data releases. So even you know middle of this week we’ll see. New PCE inflation print. So that’s the Fed’s preferred inflation gauge. It’s just gonna be, you know, investors continuing to look at every detail reports. Because it is we are getting conflicting information at this point.
00;10;56;10 – 00;11;23;14 Unknown So, it’s going to be a very reactive market. And I think it’s, you know, important to try to find, you know, all those little details that do have different implications. You know, where we could potentially see the fed having future. Yeah. So I think on a go forward basis, in addition to some of your ad hoc items like the Jackson Hole Symposium, really the major pieces of data that have high potential to move markets are, number one, any labor market data.
00;11;23;14 – 00;11;47;09 Unknown So most dominantly, that’s the first Friday of each month you get the jobs report. Number two any inflationary updates. So personal consumption expenditures or consumer price index either of those will have a heavy hand and be very heavily watched. I really think that, you know, that does add to the potential for interest rate volatility, not to front run our next topic too much.
00;11;47;09 – 00;12;17;20 Unknown But I think we just right now, given the underlying variables that we have in play, I think that investors kind of need to be comfortable with interest rate volatility, at least for the intermediate term. Here. Okay. It’s a good segue because as we look at topic number four, there has been that volatility in interest rates, not just from the perspective of Federal Reserve expectations, but in the secondary bond market, specifically the Treasury market here in the US.
00;12;17;22 – 00;12;41;24 Unknown So if you’ve been watching what you’ve seen across the Treasury yield curve, is long term Treasury yields surging. So we’ve had the 30 year Treasury reach its highest yield since 2007. We’ve had the ten year approaching 4.7%. And these are figures that are not super common, at least in recent history. So I want to talk about some of the forces that are causing these moves.
00;12;41;27 – 00;13;11;13 Unknown First, inflation remains stubborn. This has been well covered. Both today and elsewhere by us. I think that’s fairly straightforward. As inflation remains higher, you will see Treasury yields across the curve generally move up in correlation with that. Second is related to the US government. US government’s debt burden being large and continuing to grow is something that investors and treasuries will end up demanding a higher return because of, just because of potential risks that are involved.
00;13;11;15 – 00;13;36;18 Unknown And then third, this is somewhat new, I would call it to this year, is that companies are issuing a huge amount of debt, particularly to finance the AI infrastructure build out that we have seen really take form this year. I think that last point is kind of the kicker here. So the previous two inflation and high US debt burden, those are kind of structural arguments around US treasuries.
00;13;36;18 – 00;13;56;06 Unknown Right. We have those conversations. It feels like year in and year out. And we’re forced to kind of concoct some response as to why the US isn’t going to go bankrupt and default on its on its Treasury bonds. But this third point around the artificial intelligence build out, I mean, I companies and infrastructure providers have really been flooding the corporate bond market with that.
00;13;56;09 – 00;14;18;22 Unknown And as a result of that, you have investors that are increasingly demanding higher yields to absorb that supply. So we’re getting this weird combination of really large government borrowing. Also very, very significant corporate borrowing and the persistent inflation concerns. So what all this leads to is that plain and simple, investors are demanding more compensation to lend money for a long time.
00;14;18;24 – 00;14;42;10 Unknown Some of the recent actions as a result of these, these kind of yields blowing out. You’ve had the Treasury Department, Scott, percent, responding by increasing its long term bond buybacks, which has helped helped yields somewhat. Originally. And when I say this, the Treasury will on an ongoing basis, buy back some of the debt that it’s issued.
00;14;42;13 – 00;15;04;07 Unknown This is standard. And usually there is like a de minimis portion that is slated to be repurchased in any given semiannual period. But what Bezzant came out and said was that he’s basically going to double the amount of long term debt that the Treasury was going to buyback over the coming months, which is directly intended to keep a lid on longer term yields.
00;15;04;09 – 00;15;27;28 Unknown Why is he trying to do that? Well, if you have high long term bond yields, that raises cost of borrowing across the economy. Mortgages are more expensive. Corporate financing is more expensive. The government has to pay more in interest expense. And I would say just overall high bond yields make stocks look less attractive as well. So, I don’t know if there is a quick fix to this conundrum.
00;15;27;28 – 00;15;47;05 Unknown Again, some of this is structural and are points that we get asked about year in and year out around the government debt burden and and all that. But, the artificial intelligence side of things is new. And I do think it’s an interesting wrinkle that is not going to solve itself anytime soon. Yeah, I would agree with that.
00;15;47;05 – 00;16;04;06 Unknown And, you know, I think the big point there is, you know, those higher bond yields making stocks look less attractive. So that’s you know, a metric equity risk premium that, occasionally comes into focus. But yeah, you can get, you know, a similar level of return for a much less riskier asset that just makes the more risky asset less attractive.
00;16;04;06 – 00;16;25;10 Unknown So, kind of an unfortunate thing, during, you know, in the current environment we’re in with these companies spending so much money and kind of projecting our earnings further down the line. So, just. Yeah, like you said, another wrinkle in the story. Yeah. And I think it’s it’s interesting enough for us to devote, some, some specific time to that topic.
00;16;25;10 – 00;17;02;16 Unknown So final topic being how the artificial intelligence trade is starting to run into the bond market. And really, the whole tagline is just that this artificial intelligence build out, this AI boom is no longer just a technology story, and it’s no longer just an equity market story. It’s becoming a capital market story. So given that you have companies spending enormous amounts of money on building out data centers, buying chips and expanding computing capacity, what a lot of people need to realize is that a lot of that investment needs to be financed, and more often than not, that means issuing debt.
00;17;02;16 – 00;17;26;03 Unknown So we have seen some firms, we’ve seen Alphabet and Intel to name a couple that have come out and and done at the market equity issuances. But the majority of this financing is through through debt, capital markets. So we had some reporting last week around, you know, investors increasingly demanding higher yields from AI related bonds. You’ve seen tech credit spreads widen relative to the broader investment grade market.
00;17;26;06 – 00;17;49;14 Unknown This is all very visible in day to day market action. But why does that matter? Well, it’s because the whole AI investment thesis depends partly on really large future cash flows justifying those enormous investments today. So as you have interest rates rising, the cost of financing those rises to and when bond yields rise, the valuation of these call it long duration growth.
00;17;49;14 – 00;18;17;26 Unknown Stocks can come under pressure. I think you’ve seen some of this play out already, but I think the point is there are there are two very large unanswered questions as it pertains to artificial intelligence right now. The first is, when will the actual insane amounts of CapEx stop? We don’t really have any good guidance on that right now in the second piece of it is, how do you actually plan to monetize this over the long term?
00;18;18;01 – 00;18;41;27 Unknown So it’s all well and good. It’s great to see, big mature businesses from Amazon like Amazon Web Services or Microsoft, Microsoft’s Azure, printing really good results. But is that expected over the long term? So the idea behind how do we actually monetize on what is going to be the equivalent of, for some companies, $200 billion spent?
00;18;42;00 – 00;19;02;15 Unknown I think that those are two really large unanswered questions, at least right now. And until you see better clarity on that, which very well may not happen anytime soon, it wouldn’t surprise me to see some some higher demanded yields from investors to take on the debt. That’s being issued. To finance this, I build out I would agree with that.
00;19;02;16 – 00;19;23;05 Unknown You know, one thing I kind of want to point out there, as you mentioned, long duration growth stocks. So I think, you know, kind of, discussing what that means. So that’s essentially, you know, stocks where the earnings from this CapEx is expected much further out than what a short duration growth stock would be. So, you know, this time value of money that goes into that and everything.
00;19;23;05 – 00;19;42;23 Unknown So I think that’s really important to, kind of know when you’re talking about this, that it’s, you know, the money that they’re expecting to make off of all these large investments, they’re pretty far out. So you have to discount that back to today’s dollars, which makes it appear, you know, even smaller so that future earnings needs to be even more significant.
00;19;42;25 – 00;20;02;19 Unknown So, yeah, just, you know, certainly, something that investors are paying attention to right now as we see, you know, earnings next year not being massively impacted by all the spending right now. Right. And that’s just the whole long duration nature does make any change in current variables have a much bigger impact on what you’re seeing in the market.
00;20;02;21 – 00;20;27;13 Unknown So I think all of this points to, again, I don’t think it has to be like a cause for immediate alarm or anything like that, but it does all point to higher expectations for volatility across both AI related stocks and across the bond market. So it’s not just the artificial intelligence funding and that that but it’s like I said before across the Treasury yield curve given what we’ve been dealing with.
00;20;27;13 – 00;20;52;07 Unknown So trying to put it all together, I would say, you know, we talked through some of the escalating tensions between the US and Canada, talked through some recent developments in oil, how that can pertain to inflation, and then specifically covered the Federal Reserve, current happenings there and what they have to think through. Finally, closing out more explicitly on the interest rate side, talking about long dated treasuries and what’s going on there.
00;20;52;11 – 00;21;12;18 Unknown And then finally, this artificial intelligence boom creeping into a capital market story. Anything else? Vince, are we good to wrap up? I think we’re good to wrap up. All right. As always, thanks so much for joining us for another another episode of blue Chip. Now we hope to speak with you again soon.
