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Warsh Signals the Fed Still Has Inflation Work to Do · The Financial Exchange Show

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  Speaker 1: is The Financial Exchange with Chuck Zada and Paul Lane.
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  Speaker 2: Chuck, Paul, and Tucker with you here today.
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  Speaker 3: And today is the big speech from Kevin Warsh at
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  Speaker 3: the Jackson Hole Symposium today. It's ongoing as we speak
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  Speaker 3: right now, though the text of it is basically out,
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  Speaker 3: and so we have a sense of kind of what
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  Speaker 3: Warsh is going to be talking about here. And I
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  Speaker 3: think that when we look at this, Paul, the first
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  Speaker 3: big thing that I want to say is, number one,
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  Speaker 3: this is not a Fed rate decision day, so the
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  Speaker 3: expectation is not that any policy changes are actually made
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  Speaker 3: today as it relates to monetary policy.
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  Speaker 2: And also, most of the time, Fed chairs.
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  Speaker 3: Aside from a couple, you know, memorable instances, don't really
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  Speaker 3: use this as a chance to, you know, make any
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  Speaker 3: big waves. It's much more generally long-term policy focused as
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  Speaker 3: opposed to meeting-to-meeting focused.
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  Speaker 2: Absolutely.
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  Speaker 4: That's what's been the case here. 2022 is a notable
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  Speaker 4: accession with Jerome Powell coming into Jackson Hole. and really
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  Speaker 4: asserting that the Fed was going to be aggressive in
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  Speaker 4: getting inflation under control. And then you did see kind
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  Speaker 4: of a steep sell-off that preceded the markets after that.
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  Speaker 4: But this differs from that scenario. And you also have
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  Speaker 4: a Fed chair here, Chuck, that has really asserted that
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  Speaker 4: he's not going to be as communicative as his predecessor
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  Speaker 4: in Jerome Powell. And so what we're seeing here, again,
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  Speaker 4: this speech is ongoing. is he's reiterating that sort of
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  Speaker 4: declaration that he will continue to be muted as to
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  Speaker 4: what the Fed's future guidance is. Notably, he has acknowledged,
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  Speaker 4: like he has in previous instances speaking, that inflation continues
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  Speaker 4: to remain a concern of the Federal Reserve, but that
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  Speaker 4: they're going to continue to monitor things. Nothing here, at
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  Speaker 4: least from what I'm seeing, that is any sort of
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  Speaker 4: policy signaling here. And you wouldn't expect that from him either.
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  Speaker 3: No, and so I think that when you look at
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  Speaker 3: the text of the speech, and I'm going to quote
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  Speaker 3: from it just because, again, it's available on the Federal
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  Speaker 3: Reserve website now, even though he hasn't finished actually giving it,
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  Speaker 3: but look, they know what he's going to say. I'll
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  Speaker 3: quote just a couple things that I think are worth
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  Speaker 3: talking about.
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  Speaker 2: One of the big things is Warsh has.
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  Speaker 3: Discussed the idea of forward guidance, and it's mentioned in
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  Speaker 3: his speech here.
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  Speaker 2: I'll quote him.
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  Speaker 3: Forward guidance as a regular practice was adopted by my
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  Speaker 3: colleagues and me during the global financial crisis. It was
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  Speaker 3: essential at the time, and we introduced it with much fanfare.
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  Speaker 3: But as with other legacies of crises past, I believe
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  Speaker 3: the practice has overstayed its welcome. So forward guidance, when
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  Speaker 3: you boil it down to what it is, it's not saying, hey,
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  Speaker 3: here's how we're going to interpret things. Forward guidance is
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  Speaker 3: much more, this is what we are going to do
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  Speaker 3: with policy in the future.
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  Speaker 2: Guiding what you are going to do, you know, moving forward.
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  Speaker 3: So it's important to differentiate that from understanding, hey, here
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  Speaker 3: is how the Fed may react to, you know, changes
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  Speaker 3: in the economy. That's not forward guidance. Forward guidance is
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  Speaker 3: specifically saying this is what we are going to do. Quote,
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  Speaker 3: in normal times, the role of forward guidance should be
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  Speaker 3: limited and circumscribed. Otherwise, it risks creating ambiguity in the
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  Speaker 3: name of clarity. Oversharing policy deliberations and overcommitting to future
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  Speaker 3: decisions is again, that's I think the key there, can
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  Speaker 3: lead markets, businesses, and households astray. And I believe when
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  Speaker 3: policymakers make quasi-commitments on interest rates through the cycle, we
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  Speaker 3: inhibit our own freedom to make the right calls when
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  Speaker 3: it's time to decide. To get policy right, we need
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  Speaker 3: to get the relationship right between financial markets and the
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  Speaker 3: central bank. The Fed needs clear market signals as unfiltered
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  Speaker 3: as possible.
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  Speaker 2: Blah, blah, blah, blah, blah.
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  Speaker 3: These and other indicators should inform the Fed's near-term outlook
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  Speaker 3: on economic activity and inflation throughout the business cycle. So, again,
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  Speaker 3: nothing new from Warsh, kind of what he's been saying,
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  Speaker 3: you know, for the first three months of his tenure. Hey,
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  Speaker 3: I don't want the Fed to be giving too much
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  Speaker 3: of a hint as to what we are going to do.
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  Speaker 3: I want to let markets interpret the data and figure
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  Speaker 3: things out a little bit more.
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  Speaker 4: The challenging thing here for Warsh, and I don't anticipate
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  Speaker 4: him hitting on this during this particular speech here, is
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  Speaker 4: on the longer end of the curve, Treasury Secretary Scott
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  Speaker 4: Besson had come out last week increasing some of the
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  Speaker 4: bond buybacks, which creates sort of a thorn in the
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  Speaker 4: side of this approach as to let the market conditions
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  Speaker 4: and market prices dictate sort of what we should do
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  Speaker 4: from a policy perspective. You now have a degree of,
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  Speaker 4: maybe interference is too strong of a word, but certainly
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  Speaker 4: a push by the Treasury side of things to really
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  Speaker 4: get longer term interest rates under control. And again, I
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  Speaker 4: don't anticipate that Kevin Wurst says anything here. And Chuck,
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  Speaker 4: you have the text in front of you. So I
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  Speaker 4: don't think anything's mentioned on that front. But that does
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  Speaker 4: create a bit of ambiguity in terms of his focus,
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  Speaker 4: which has been just use the market prices and the
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  Speaker 4: information that you're getting from the markets to make your
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  Speaker 4: sort of decision as to where things are trending and
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  Speaker 4: less leaning on what we say, but a bit complicated
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  Speaker 4: by some of the measures that have been taken. by
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  Speaker 4: the Treasury in the last week or so here.
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  Speaker 3: Now, I want to go on and detail one other piece.
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  Speaker 3: He has a section in his speech on key principles,
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  Speaker 3: and the first two don't really say much of anything,
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  Speaker 3: which is fine.
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  Speaker 2: They don't need to.
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  Speaker 3: But I think the middle ones, he has seven that
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  Speaker 3: he lays out here. I think the middle three or
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  Speaker 3: four have some meat on them that, if he sticks
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  Speaker 3: to them, is going to make him successful here.
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  Speaker 2: Third, there should be no misunderstanding.
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  Speaker 3: The Fed's price stability objective of 2% as measured by
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  Speaker 3: the Personal Consumption Expenditures Price Index, is a firm fixed target.
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  Speaker 3: Let me be equally clear that another aspect of the objective,
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  Speaker 3: price stability is not self-executing, nor is inflation necessarily mean reverting.
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  Speaker 3: It is the Fed's job to deliver stable prices. So
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  Speaker 3: full stop right there. One of the problems with his
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  Speaker 3: last press conference, someone asked him, hey, are you going
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  Speaker 3: to be keeping... uh, PCE and core PC is like your,
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  Speaker 3: your targets. And he was like, well, we're, we may
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  Speaker 3: examine that. And that was one of the places where
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  Speaker 3: the bond market started to go off the rails. And
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  Speaker 3: so him coming back and being like, no, this is
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  Speaker 3: what we're focusing on.
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  Speaker 2: Good.
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  Speaker 3: Like if you want to change the inflation target or
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  Speaker 3: the inflation metrics, it's fine. At some point, you can't
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  Speaker 3: do it when inflation's running North of 3%.
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  Speaker 2: You got to do it after you've succeeded.
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  Speaker 3: Once you get inflation down, then you can be like,
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  Speaker 3: now that we've done this, we don't think this is
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  Speaker 3: the best metric.
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  Speaker 2: Here's what we're going to use going forward.
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  Speaker 3: But it's kind of like, hey, I'm running a marathon
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  Speaker 3: and I want to hit three hours.
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  Speaker 2: Well, you know what? I've actually decided to hit 330.
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  Speaker 3: Well, no, like after you finish the marathon, then you
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  Speaker 3: can target a slower time next time. But otherwise, finish
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  Speaker 3: the race. Finish the race first. Fourth, the Fed also
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  Speaker 3: bears responsibility for maximum employment. Okay, so he hasn't really
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  Speaker 3: talked about that much, but acknowledging it's a piece there. Fifth,
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  Speaker 3: short-term interest rates are the predominant tool to achieve the
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  Speaker 3: dual mandate. Unconventional policies to spur economic activity may suit
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  Speaker 3: genuine crises, but should otherwise be used sparingly, if at all.
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  Speaker 3: So basically saying, look, all the other stuff that has
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  Speaker 3: been done previously, you know, balance sheet and this and that,
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  Speaker 3: we want to use that less.
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  Speaker 2: Got it.
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  Speaker 3: Okay, like, we'll see how it goes, but I've got
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  Speaker 3: it there. So I think those three kind of encapsulate, okay,
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  Speaker 3: here's really what I want to do. And now, as
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  Speaker 3: we've said since the beginning of his tenure, it's going
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  Speaker 3: to be, okay, go out and execute it.
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  Speaker 4: Right, right. Make your decision on the rate front. Heading
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  Speaker 4: into this speech yesterday, we were looking at the probabilities
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  Speaker 4: of rates staying where they are for the upcoming meeting
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  Speaker 4: in the middle of September at about 65-35%. only a
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  Speaker 4: 35% probability that there would be a hike. We're now
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  Speaker 4: seeing those shift a little bit. I think these are
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  Speaker 4: as of 10 o'clock here, the update on the futures,
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  Speaker 4: where it's a little bit more being added to this
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  Speaker 4: idea that potentially we would see a rate hike here
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  Speaker 4: in the September meeting, now closer to a 58-42 split
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  Speaker 4: after some of his remarks have been digested.
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  Speaker 3: So we'll have a little bit more to talk about
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  Speaker 3: on this, but let's take a quick break. And when
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  Speaker 3: we return, we'll wrap up some additional thoughts on what
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  Speaker 3: Warsh is saying here and then talk a little bit about, hey,
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  Speaker 3: how are things going to interact between the Fed and
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  Speaker 3: the Treasury going forward?
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  Speaker 2: Forward?
• 10:01
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• 10:33
  Speaker 3: Paul, anything else that you want to add on Kevin Warsh,
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  Speaker 3: what he's saying today?
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  Speaker 2: Any other pieces we've missed so far?
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  Speaker 4: No, and it looks like I think my biggest thing
• 10:44
  Speaker 4: would be just for listeners out there, markets relatively unchanged.
• 10:47
  Speaker 4: Like we were saying earlier in the show, not a
• 10:50
  Speaker 4: huge reaction to this. Nothing here that was earth shattering.
• 10:53
  Speaker 4: Markets are in kind of neutral territory. And then the U.S.
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  Speaker 4: 10-year treasury is up. you know, two basis points. I
• 11:00
  Speaker 4: guess we got a little bit of a jump on
• 11:01
  Speaker 4: the U.S. two-year treasuries because of his comments on the
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  Speaker 4: Fed saying that they may have more work to do.
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  Speaker 4: But other than that, it's been relatively muted in terms
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  Speaker 4: of the market sort of analyzing this speech here.
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  Speaker 3: So I think that what's going to be interesting to
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  Speaker 3: watch the next couple months, this all comes from the
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  Speaker 3: last week or so now, is the tension in ideas
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  Speaker 3: between worse saying, Hey, I want to let the market
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  Speaker 3: speak for itself. And Scott Besson, the treasury tech secretary
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  Speaker 3: putting in place plans for a larger long-term treasury buyback
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  Speaker 3: program and saying, Hey, like we might do even more
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  Speaker 3: if we think it's appropriate. How do we balance these
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  Speaker 3: ideas and how's the market going to figure out what
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  Speaker 3: the rules of the game are now? Yeah.
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  Speaker 4: And what we have to look back to is just for,
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  Speaker 4: for listeners, the, Treasury came out last week stating that
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  Speaker 4: they would double their buybacks in terms of what they
• 12:00
  Speaker 4: see in terms of weekly auctions. Usually, that is only
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  Speaker 4: done when there are liquidity forces at play that are
• 12:06
  Speaker 4: creating issues. This was not a liquidity situation. To quote
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  Speaker 4: Stanley Druckenmeier, Miller, who wrote a piece on it over
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  Speaker 4: the weekend, it was more about price management, trying to
• 12:18
  Speaker 4: drive up the price of longer-term bards, therefore driving down yields,
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  Speaker 4: basically to get the 10-year treasury under control. The 30-year
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  Speaker 4: treasury is running at 17 or 18-year highs. When Warsh
• 12:31
  Speaker 4: is saying, okay, you got to analyze the market and
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  Speaker 4: what it is pricing in, it's hard to combat that
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  Speaker 4: with a treasury secretary that is making a concerted effort
• 12:41
  Speaker 4: and has left for more room to try and further
• 12:45
  Speaker 4: influence the treasury market. The positive thing there, or the
• 12:49
  Speaker 4: argument that Warsh could make, is that this treasury market
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  Speaker 4: is incredibly liquid and the volumes that we see on
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  Speaker 4: a trading basis daily are far more significant than these
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  Speaker 4: buyback efforts could really make a significant dent into. But
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  Speaker 4: some of the pricing that you see with yields are
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  Speaker 4: based on what investors are thinking from the economy and
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  Speaker 4: the market in the future. And if they're pricing in
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  Speaker 4: this idea that the Fed, the Treasury rather, really wants
• 13:18
  Speaker 4: to keep rates under control, that can have an impact.
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  Speaker 4: It has been muted since this announcement last Friday, but
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  Speaker 4: it is something that they'll have to contend with going forward.
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  Speaker 4: And I just wonder if this is really the, I'm
• 13:35
  Speaker 4: of the opinion, it's not the best way to go
• 13:36
  Speaker 4: at this if you're Treasury Secretary Besant, there are other
• 13:40
  Speaker 4: structure falls in place with the U S debts situation,
• 13:44
  Speaker 4: whether it's fiscal deficit or just the amount of cumulative
• 13:47
  Speaker 4: debt we have out there and trying to play with
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  Speaker 4: the interest rate side to me just doesn't seem like
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  Speaker 4: the best approach. Yeah.
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  Speaker 3: And I think the, the big thing that I think
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  Speaker 3: is going to matter most here is still what does
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  Speaker 3: Kevin Warsh actually want to do from a policy perspective?
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  Speaker 3: Because we, we talked about this last week in that, uh, Ultimately,
• 14:10
  Speaker 3: if you're talking about who has more firepower, it's always
• 14:13
  Speaker 3: the Fed relative to the Treasury, because the Fed can
• 14:15
  Speaker 3: print money, whereas the Treasury cannot. The Treasury, in order
• 14:18
  Speaker 3: to fund anything, has to borrow. The Fed does not.
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  Speaker 3: And so I think that the big question that still
• 14:26
  Speaker 3: is out there is, look, this... By, you know, just
• 14:29
  Speaker 3: about every.
• 14:31
  Speaker 3: Again, you look at what's happening in the yield curve
• 14:34
  Speaker 3: and in precious metals and in the dollar, and basically
• 14:38
  Speaker 3: markets today are looking at this speech and saying, okay,
• 14:41
  Speaker 3: this is more of what we wanted. Again, you've got
• 14:44
  Speaker 3: short-term yields moving up a little bit. You've got long-term
• 14:48
  Speaker 3: yields basically flat when you look at anything 20 years
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  Speaker 3: further and out in the 10 years up, you know,
• 14:54
  Speaker 3: a couple basis points.
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  Speaker 2: But, like, that's what you want to see.
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  Speaker 3: If you want to, you know, If you want to
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  Speaker 3: believe that the market is becoming convinced that the Fed
• 15:03
  Speaker 3: will act more hawkishly if needed, you want short-term rates
• 15:06
  Speaker 3: moving up and long-term rates flat to down. That's the
• 15:09
  Speaker 3: signal that you're getting. The dollar strengthening on this. Gold
• 15:13
  Speaker 3: selling off a bit on this. So the market is saying,
• 15:16
  Speaker 3: give me more of this speech in your actions and
• 15:20
  Speaker 3: what you say going forward.
• 15:22
  Speaker 2: Got it.
• 15:24
  Speaker 3: The question that's out there still is, okay, like what...
• 15:29
  Speaker 3: Who is, you remember back in the late 90s, a
• 15:34
  Speaker 3: fellow by the name of Eminem?
• 15:36
  Speaker 1: Yes.
• 15:37
  Speaker 4: Right.
• 15:37
  Speaker 3: So Eminem, you know, had a song, you know, won't
• 15:42
  Speaker 3: the real Slim Shady please stand up? And we're kind
• 15:45
  Speaker 3: of there with Kevin Warsh right now. It's like, okay,
• 15:47
  Speaker 3: who's the real Kevin Warsh? Can he please stand up?
• 15:49
  Speaker 3: Is it this guy who, in two out of three
• 15:52
  Speaker 3: speeches now, has come out and said, I am going
• 15:55
  Speaker 3: to be an inflation fighter and we'll do what we
• 15:57
  Speaker 3: need to do?
• 15:58
  Speaker 1: Yep.
• 15:59
  Speaker 3: Or is it the kind of wishy-washy, well, we're just
• 16:03
  Speaker 3: not sure. We didn't actually pause. We're just looking for
• 16:06
  Speaker 3: more information. Show me who you're going to be. And
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  Speaker 3: I think the big thing is the market just doesn't
• 16:13
  Speaker 3: know who he's going to be yet because he doesn't
• 16:16
  Speaker 3: want to tell them, and that's fine. He doesn't have to,
• 16:20
  Speaker 3: but at some point he's going to have to Not
• 16:23
  Speaker 3: he's going to have to act.
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  Speaker 2: Every meeting, he is acting.
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  Speaker 3: By either doing nothing, cutting, or hiking.
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  Speaker 2: And so if we.
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  Speaker 3: The problem last meeting is there was a divergence between, well,
• 16:35
  Speaker 3: you're talking hawkishly, but you're not doing anything. And at
• 16:38
  Speaker 3: a certain point, if that continues, then there are going
• 16:41
  Speaker 3: to be larger problems in these markets. If it doesn't,
• 16:45
  Speaker 3: because either the data gets better or because they hike
• 16:48
  Speaker 3: and they trust that the market trusts that he'll hike...
• 16:51
  Speaker 3: then that'll be fine too. But right now, we don't
• 16:54
  Speaker 3: know who the real Kevin Warsh is. We're still trying
• 16:56
  Speaker 3: to figure that out. And that's fine. It's been a
• 16:58
  Speaker 3: few months and we can give it some time for
• 17:01
  Speaker 3: that to sort itself out.
• 17:03
  Speaker 4: We'll get two more data points that he'll have to
• 17:05
  Speaker 4: digest before the next Federal Reserve meeting. We'll get a
• 17:08
  Speaker 4: jobs report. I believe that's September 4th or early in
• 17:12
  Speaker 4: the month. And then September 11th, we'll get an inflation
• 17:15
  Speaker 4: report out. But then to your point, he really is
• 17:18
  Speaker 4: going to have to try again. he's really going to
• 17:21
  Speaker 4: have to be put to the test in terms of
• 17:23
  Speaker 4: what he's going to do. That September 16th meeting, like
• 17:26
  Speaker 4: you mentioned, last meeting we had three officials dissenting. What
• 17:30
  Speaker 4: does it look like on the 16th? And those two
• 17:33
  Speaker 4: economic reports will have, I'm sure, some weighting as to
• 17:36
  Speaker 4: what that decision is. And it's, all right, you've talked
• 17:40
  Speaker 4: a good game, two out of three speeches. Are you
• 17:42
  Speaker 4: going to take measures on the 16th with a potential
• 17:45
  Speaker 4: hike to back up your words? If you have a
• 17:48
  Speaker 4: situation where they hold back, then the markets are going
• 17:51
  Speaker 4: to be confused or maybe think he's kind of full
• 17:53
  Speaker 4: of it on these speeches versus what the ultimate actions are.
• 17:58
  Speaker 3: Now, in terms of data points that can move either
• 18:00
  Speaker 3: Warsh or other members of the Fed before then, there's
• 18:03
  Speaker 3: a few big ones that have the potential to change things.
• 18:07
  Speaker 3: On Tuesday of next week, we've got the JOLTS report,
• 18:10
  Speaker 3: job openings. So we'll see what that says. On Friday
• 18:15
  Speaker 3: of next week, we have the jobs report for August.
• 18:19
  Speaker 3: Those are both potentially things that can move one or
• 18:22
  Speaker 3: more Fed members. The following Thursday, the 10th, we've got
• 18:28
  Speaker 3: producer price index data coming out. On Friday, the 11th,
• 18:31
  Speaker 3: we have CPI, consumer price index data coming out. And
• 18:35
  Speaker 3: then the Fed meeting is the following week, the day
• 18:38
  Speaker 3: that we also get retail sales for the month of August.
• 18:40
  Speaker 3: That's potentially something that can move things a little bit
• 18:43
  Speaker 3: as well. So there are three, maybe four data points
• 18:47
  Speaker 3: in the next two weeks where... Hey, hot jobs report
• 18:51
  Speaker 3: and hot inflation? Okay, like that increases the likelihood of
• 18:55
  Speaker 3: a hike. Cool jobs report and cool inflation? Okay, the
• 18:59
  Speaker 3: Fed could be, you know, convinced to hold off.
• 19:02
  Speaker 2: Mix of them?
• 19:04
  Speaker 3: Grab bag, toss up, you know, you don't know what
• 19:05
  Speaker 3: you're going to get. So this is kind of the
• 19:08
  Speaker 3: situation heading into the next couple weeks that I think
• 19:11
  Speaker 3: is a pretty important, pretty interesting period for monetary policy.
• 19:16
  Speaker 2: Quick break here. Wall Street Watch is next.
• 19:26
  Speaker 1: Like us on Facebook and follow us on Twitter at TFEShow.
• 19:30
  Speaker 1: Breaking business news is always first, right here on the
• 19:33
  Speaker 1: Financial Exchange Radio Network. Time now for Wall Street Watch.
• 19:39
  Speaker 1: Tracking the stocks, the data, and the headlines driving markets
• 19:42
  Speaker 1: so far today, right here on the Financial Exchange Radio Network.
• 19:46
  Speaker 5: All eyes on Jackson Hole this morning where Fed Chairman
• 19:49
  Speaker 5: Kevin Rees... just delivered his first keynote address at the
• 19:53
  Speaker 5: annual conference. The biggest takeaway, Walsh said inflation isn't slowing
• 19:58
  Speaker 5: and vows to hit the Fed's 2% target. Right now,
• 20:03
  Speaker 5: the Dow is off only 14 points. S & P
• 20:06
  Speaker 5: 500 edging six points higher. NASDAQ only up by five points.
• 20:11
  Speaker 5: Russell 2000 is down about half a percent. 10-year treasury
• 20:15
  Speaker 5: yield is up only one basis point at 4.68%. And
• 20:20
  Speaker 5: oil down about eight-tenths of a percent, trading at $ 82
• 20:24
  Speaker 5: a barrel. So markets mostly quiet after Warsh's address. Marvell
• 20:28
  Speaker 5: Technology reported higher revenue and earnings in the previous quarter,
• 20:31
  Speaker 5: where the semiconductor company raised its guidance for the current
• 20:35
  Speaker 5: and upcoming fiscal years. However, investors are seemingly not impressed
• 20:40
  Speaker 5: by its 2028 fiscal outlook, sending shares in Marvell down
• 20:46
  Speaker 5: nearly 7%. Meanwhile, Bloomberg reported that a consortium, including Advent
• 20:51
  Speaker 5: and Stripe, decided to abandon its pursuit of digital payments
• 20:55
  Speaker 5: company PayPal. PayPal stock is sinking 11% on that news.
• 21:00
  Speaker 5: And retailer Gap is seeing its stock rally 15% after
• 21:04
  Speaker 5: the company announced it hired retail veteran Michael Francis as
• 21:08
  Speaker 5: its next CEO of Old Navy, its largest brand. Francis
• 21:12
  Speaker 5: has previous experience at Target in the early 2000s and
• 21:17
  Speaker 5: served as a key consultant at Walmart for about a decade.
• 21:22
  Speaker 5: I'm Tucker Silva and that is Wall Street Watch.
• 21:25
  Speaker 3: Paul, just one last item of cleanup when we talk
• 21:29
  Speaker 3: about the Jackson Hole Symposium. I've got just a couple
• 21:34
  Speaker 3: of quotes that I want to read. Just, again, kind
• 21:38
  Speaker 3: of the hawkish tint that Warsh's remarks had. Quote, on balance,
• 21:45
  Speaker 3: I would be hard-pressed to describe broad financial conditions as restrictive. So, again,
• 21:51
  Speaker 3: he talked about like there's some pockets that, you know,
• 21:53
  Speaker 3: that might be the case, but broadly, you know, kind of, Yeah,
• 21:56
  Speaker 3: I could see this not being restrictive right now. While
• 21:59
  Speaker 3: this summer's PCI and CPI readings were better than expected,
• 22:03
  Speaker 3: they do not tell me that underlying trends have meaningfully improved.
• 22:07
  Speaker 3: And I think you look at those two quotes and look,
• 22:10
  Speaker 3: by and large, this is worse kind of falling in
• 22:12
  Speaker 3: line with where the committee, I think, you know, looks
• 22:18
  Speaker 3: like they were going over the last, you know, six
• 22:21
  Speaker 3: to 10 weeks. And so I do think that this
• 22:24
  Speaker 3: is potentially setting up for a September hike, which doesn't
• 22:27
  Speaker 3: really mean a ton again, like one hike is not
• 22:30
  Speaker 3: going to change the trajectory.
• 22:32
  Speaker 2: Of the economy.
• 22:34
  Speaker 3: It's if you start to see two, three, four, if
• 22:37
  Speaker 3: there's a cycle that builds there, now you've got something
• 22:39
  Speaker 3: that's interesting, but potentially setting up for a September hike.
• 22:43
  Speaker 2: But we'll have to see how things play out.
• 22:44
  Speaker 3: Any other items just that you want to touch on
• 22:46
  Speaker 3: before we move on to talking a little bit about AI?
• 22:51
  Speaker 4: Good to move on to AI.
• 22:53
  Speaker 2: All right.
• 22:53
  Speaker 3: So we got a piece in the Wall Street Journal,
• 22:55
  Speaker 3: how the AI investment craze is keeping the global economy afloat.
• 23:00
  Speaker 2: What are we doing here, Paul?
• 23:02
  Speaker 4: So ING estimates that one third of the recent economic
• 23:07
  Speaker 4: growth from a GDP perspective for the US has come
• 23:10
  Speaker 4: from AI investment. And we've covered it heavily on this show.
• 23:13
  Speaker 4: You've got these two counter forces in place. One that
• 23:16
  Speaker 4: we focus on quite a bit is there's this supply
• 23:19
  Speaker 4: shock going on in the Middle East over the course
• 23:21
  Speaker 4: of the last six months during COVID. The war that
• 23:24
  Speaker 4: has ensued between U.S. and Iran, and that has put
• 23:27
  Speaker 4: a lot of upward pricing on pricing pressure on commodities,
• 23:32
  Speaker 4: oil and gas, etc. But at the same point in time,
• 23:34
  Speaker 4: we sit with a market here that is up 13
• 23:37
  Speaker 4: or 14 percent year to date. All of us know,
• 23:40
  Speaker 4: or all of us should know, that a lot of
• 23:42
  Speaker 4: that is because of a significant portion of it, I
• 23:45
  Speaker 4: guess I would say. It's from the positive demand that
• 23:47
  Speaker 4: we've seen from AI. Whether you look domestically and many
• 23:52
  Speaker 4: of the companies that have benefited here, we just saw
• 23:54
  Speaker 4: NVIDIA with robust earnings reported earlier this week, and their
• 23:59
  Speaker 4: stock rising 6% or 7% on the backs of that.
• 24:01
  Speaker 3: Yeah.
• 24:04
  Speaker 4: Insisting that they will see 70% revenue growth heading into
• 24:07
  Speaker 4: their fiscal 2028 year. So really good numbers that we
• 24:10
  Speaker 4: saw there. If you look even internationally, Japan and Taiwan
• 24:14
  Speaker 4: and South Korea have seen their exports surge dramatically. And
• 24:18
  Speaker 4: so what you have is there are just numerous areas
• 24:21
  Speaker 4: of the economy that are running on all cylinders. whether
• 24:25
  Speaker 4: you look at semiconductors, electronic equipment, cables, metals, machinery, just
• 24:30
  Speaker 4: look at a company like Caterpillar or areas that you
• 24:34
  Speaker 4: wouldn't think of AI, but they're benefiting from kind of
• 24:37
  Speaker 4: the picks and shovels that are going into the ground.
• 24:40
  Speaker 4: That has really been the story. What goes with that
• 24:44
  Speaker 4: though is what the market continues to focus on every
• 24:47
  Speaker 4: single day is how long can this sustain for? How
• 24:50
  Speaker 4: long can we continue to have this robust growth from
• 24:55
  Speaker 4: everything that we're seeing from the hyperscalers, which are the
• 24:58
  Speaker 4: biggest drivers of all this expense, it's going to continue
• 25:02
  Speaker 4: on to 2027. But what I love talking about on
• 25:05
  Speaker 4: a daily basis is trying to figure out how long
• 25:09
  Speaker 4: the momentum can continue. But that really has been the
• 25:12
  Speaker 4: story is that AI investment has been keeping this economy going. When.
• 25:18
  Speaker 3: When looking at this, I fully acknowledge that that's true.
• 25:22
  Speaker 3: The counterfactual, meaning, okay, let's say that AI, let's say
• 25:26
  Speaker 3: this was never a thing. If economic growth in general
• 25:31
  Speaker 3: were weaker then, you would probably have lower interest rates,
• 25:35
  Speaker 3: which would probably mean that you'd have other areas of
• 25:39
  Speaker 3: the economy. Maybe housing is stronger at that point. Maybe
• 25:43
  Speaker 3: there are other things that are picking up. And so
• 25:46
  Speaker 3: this is the part that's difficult to untangle here, is that, okay,
• 25:50
  Speaker 3: so yes, you have this AI boom that's happening that's
• 25:53
  Speaker 3: creating all this economic activity. If it were not, it's
• 25:57
  Speaker 3: not as simple as just saying, well, you take that
• 25:59
  Speaker 3: out and the economy would be terrible.
• 26:02
  Speaker 2: Not necessarily.
• 26:02
  Speaker 3: If the economy's weaker, interest rates are lower, and maybe
• 26:05
  Speaker 3: mortgage rates are at five and a half instead of
• 26:07
  Speaker 3: six and a half, and maybe there are an extra
• 26:09
  Speaker 3: couple hundred thousand houses.
• 26:11
  Speaker 2: That are getting built each year instead.
• 26:12
  Speaker 3: So, It's not to poo-poo the AI side of things
• 26:16
  Speaker 3: when it comes to the growth, but in any of this,
• 26:18
  Speaker 3: you can't just say, well, take that away and it
• 26:21
  Speaker 3: would be bad. Well, no, it would be different, but
• 26:25
  Speaker 3: there's a complex series of interactions that happens in order
• 26:28
  Speaker 3: to drive different levels of economic activity in different parts
• 26:31
  Speaker 3: of the economy.
• 26:33
  Speaker 4: Completely agree with that. In prepping for the show today,
• 26:36
  Speaker 4: there were some comparisons made to 2021 in terms of
• 26:39
  Speaker 4: the CapEx numbers that we saw then are far less
• 26:42
  Speaker 4: than where they are today. But think about what the
• 26:44
  Speaker 4: market was in 2021. It was a really good market.
• 26:48
  Speaker 4: And a lot of that was due to the fact that, hey,
• 26:51
  Speaker 4: like you just mentioned, interest rates were lower. There was
• 26:53
  Speaker 4: a lot of demand coming out of COVID. The savings
• 26:56
  Speaker 4: rate had really run up significantly. And as a result
• 26:59
  Speaker 4: of that, you were seeing tremendous consumption trends from a
• 27:02
  Speaker 4: lot of the United States and other countries throughout the world.
• 27:05
  Speaker 4: So I fully acknowledge that, but it has gotten to
• 27:09
  Speaker 4: a point where this momentum has You're right. Absent AI,
• 27:14
  Speaker 4: there probably would be something else that you and I
• 27:16
  Speaker 4: would be talking about that maybe could be benefiting markets.
• 27:19
  Speaker 4: But going forward, it's hard to make the argument that
• 27:23
  Speaker 4: if you don't have AI continuing to grow and revenue
• 27:28
  Speaker 4: attributable from it, that the market would stay afloat. It's
• 27:33
  Speaker 4: just so much has been put behind it. I just
• 27:35
  Speaker 4: don't think you can sub in something else at this point.
• 27:37
  Speaker 4: We're kind of too far gone in terms of some
• 27:39
  Speaker 4: of the numbers that we're seeing here.
• 27:42
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• 28:35
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• 28:37
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• 28:46
  Speaker 3: Now we get this piece, Paul. Is the AI CapEx
• 28:49
  Speaker 3: bubble about to burst? what 250 years of market history
• 28:53
  Speaker 3: tell us. Tell me, Paul, what do those 250 years
• 28:56
  Speaker 3: tell us?
• 28:57
  Speaker 4: So what has been talked about frequently in comparison to
• 29:00
  Speaker 4: the AI spending is two analogies come up or two
• 29:03
  Speaker 4: historical examples come up most often when you're looking at
• 29:07
  Speaker 4: this issue. The railroads of the 1860s and 1870s build out.
• 29:12
  Speaker 1: Yep.
• 29:12
  Speaker 4: That is one big one. And the other one is
• 29:14
  Speaker 4: what we saw in the late 90s and the cable
• 29:18
  Speaker 4: fiber cable build out throughout the the late 90s and
• 29:22
  Speaker 4: what this piece goes over in Barron's is first what
• 29:25
  Speaker 4: we can draw from those examples one of the statistics
• 29:28
  Speaker 4: that is leaned on most heavily in this piece is
• 29:30
  Speaker 4: this idea that in past cycles like this where there
• 29:34
  Speaker 4: was just tremendous amounts of money thrown at one new
• 29:37
  Speaker 4: technological innovation it was until the point in time where
• 29:42
  Speaker 4: the amount of expense on this specific area of investment,
• 29:45
  Speaker 4: whether it be the railroads of the 1860s or the
• 29:47
  Speaker 4: internet boom in the 90s, once it was 25%, the
• 29:50
  Speaker 4: amount of money being spent relative to the amount of
• 29:52
  Speaker 4: GDP that started to turn to be the tipping point
• 30:02
  Speaker 4: of when it would be overly concerning and potentially leading
• 30:05
  Speaker 4: to sort of a flame out. So if you look
• 30:08
  Speaker 4: back at the late 90s, our GDP was around $ 6 trillion.
• 30:12
  Speaker 4: It wasn't until spending on the internet build out reached
• 30:17
  Speaker 4: one and a half trillion that it sort of started
• 30:19
  Speaker 4: to become problematic. Similarly with the 1860s, GDP floating around
• 30:24
  Speaker 4: $ 10 billion a year. In 1873, we saw expenditures on
• 30:29
  Speaker 4: the railroads exceed $ 2. 5 billion, and that's where it started
• 30:32
  Speaker 4: to eventually burn out. Again, you can't just use these
• 30:36
  Speaker 4: statistics from two specific historical examples as the way to
• 30:42
  Speaker 4: measure the AI CapEx build-out. The argument being made here
• 30:45
  Speaker 4: is that we are far from that today. We sit
• 30:48
  Speaker 4: with a GDP of $ 30 trillion. That would imply that $ 7. 5
• 30:52
  Speaker 4: trillion of spending domestically would need to occur today. to
• 30:56
  Speaker 4: get to these levels again, right? Every time is different,
• 30:59
  Speaker 4: but when you're trying to gauge this, it does help
• 31:02
  Speaker 4: to look back at historical examples. And this is just
• 31:05
  Speaker 4: what is laid out in the Barron's piece here. There
• 31:08
  Speaker 4: are many factors that differ greatly from what we saw
• 31:12
  Speaker 4: with the railroads and internet as well.
• 31:15
  Speaker 3: The big thing is, there are two things that are
• 31:19
  Speaker 3: true in my opinion. The number one is five, seven
• 31:24
  Speaker 3: years from now, On the whole, we're all going to
• 31:28
  Speaker 3: be using AI a lot more than we do today.
• 31:30
  Speaker 2: Yep. Full stop.
• 31:33
  Speaker 3: The second one, though, is if for some reason this
• 31:36
  Speaker 3: level of investment doesn't end with some kind of bust
• 31:41
  Speaker 3: because of too much capital being directed in one area,
• 31:45
  Speaker 3: it'll pretty much be the first time that that's ever happened.
• 31:47
  Speaker 3: Because any time that you have excitement about new technologies,
• 31:51
  Speaker 3: you get new hot money that's chasing after these returns
• 31:55
  Speaker 3: and trying to make trillions of dollars or billions of dollars,
• 31:58
  Speaker 3: whatever it is at the time. And money chases after it,
• 32:03
  Speaker 3: and some of it finds productive uses, and some of
• 32:06
  Speaker 3: it does not. And so it would be absolutely shocking
• 32:10
  Speaker 3: if either we're not using more AI five to seven
• 32:14
  Speaker 3: years from now, or if.
• 32:18
  Speaker 3: After this is all said and done, there isn't some
• 32:20
  Speaker 3: level of significant shakeout that costs investors in certain companies
• 32:26
  Speaker 3: lots of money, if not all of their money, because
• 32:29
  Speaker 3: that's how it always tends to go. Now, you also
• 32:32
  Speaker 3: end up with, out of any of these... Again, from
• 32:35
  Speaker 3: the railroads, you came out with a bunch of productive infrastructure.
• 32:37
  Speaker 3: From the airlines, in development of air travel, you came
• 32:40
  Speaker 3: out with a bunch. Those of you who are listening
• 32:42
  Speaker 3: to us right now, I know some of you are
• 32:45
  Speaker 3: on the YouTube and the Twitter, but there's a lot
• 32:49
  Speaker 3: of you that are listening to us on radio. The
• 32:51
  Speaker 3: build-out of radio in the early days was the same way.
• 32:53
  Speaker 3: Think about all of the radio stations that would belly
• 32:56
  Speaker 3: up after the development of radio. And so I think
• 33:01
  Speaker 3: that it would be really surprising if... 10 years from now,
• 33:06
  Speaker 3: we sit back and we're like, you know what? The
• 33:08
  Speaker 3: amount of capital that was spent developing AI was the
• 33:11
  Speaker 3: exact right amount.
• 33:14
  Speaker 2: Well, no, it never is.
• 33:16
  Speaker 3: I see people being like, well, what's the plan for
• 33:18
  Speaker 3: all this? And I'm like, guys, here's the thing. There's
• 33:21
  Speaker 3: no master plan for any of this, and there doesn't
• 33:26
  Speaker 3: need to be. There never is a master plan. The
• 33:28
  Speaker 3: way we go through this is with these cycles of excitement,
• 33:31
  Speaker 3: and then capital gets destroyed because of overinvestment, and that's
• 33:35
  Speaker 3: how it goes. You can't master plan your way through this.
• 33:40
  Speaker 2: You're not the Soviets. It didn't work. It won't work.
• 33:42
  Speaker 3: You can't just master plan through this. The place where
• 33:45
  Speaker 3: I do think there are some problems are hey, if
• 33:48
  Speaker 3: in the early days you were testing a plane and
• 33:52
  Speaker 3: it crashed, okay, it affected the people on board, which
• 33:55
  Speaker 3: is not good.
• 33:56
  Speaker 2: We get that.
• 33:57
  Speaker 3: With AI, we've seen in the last month or so, okay,
• 34:00
  Speaker 3: this has the potential to impact people that aren't involved
• 34:04
  Speaker 3: in any way, shape, or form in AI. It's just
• 34:05
  Speaker 3: maybe the platform that they're using gets hacked by it
• 34:08
  Speaker 3: and something happens and their life is.
• 34:11
  Speaker 2: Hurt as a result of it.
• 34:12
  Speaker 3: So that's the only place that I think is different
• 34:15
  Speaker 3: is that The scale for things to go wrong is
• 34:18
  Speaker 3: larger because of how interconnected everything is. But that's different
• 34:24
  Speaker 3: from saying we should plan this. You can't plan this.
• 34:27
  Speaker 3: You don't want to plan this. Capital has to seek
• 34:30
  Speaker 3: out returns, and sometimes it finds them, and sometimes it
• 34:32
  Speaker 3: gets destroyed.
• 34:33
  Speaker 2: That's just kind of how it goes.
• 34:34
  Speaker 3: Let's take a quick break here. When we return, a
• 34:38
  Speaker 3: little bit more about NVIDIA next.
• 34:41
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• 34:44
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• 35:27
  Speaker 2: Paul, we got a piece in the Wall Street Journal.
• 35:28
  Speaker 3: NVIDIA insists it can keep printing money to fund the
• 35:31
  Speaker 3: AI boom. And I'll be honest, at least for the
• 35:35
  Speaker 3: next 12 to 18 months, which is about as far
• 35:37
  Speaker 3: ahead as you can look at any of this, yeah,
• 35:39
  Speaker 3: there doesn't seem to be any issue to them doing that.
• 35:42
  Speaker 4: It seems like if you look through that earnings report
• 35:45
  Speaker 4: that we saw last, what was that, Wednesday night that
• 35:48
  Speaker 4: came out? Yeah, Wednesday night. They're anticipating that they're going
• 35:52
  Speaker 4: to be coming in at close to $ 100 billion a
• 35:54
  Speaker 4: quarter here in revenue going forward. So there is a
• 35:57
  Speaker 4: ton of revenue that they're generating and a ton of
• 36:00
  Speaker 4: profitability too. It's just an interesting spot that NVIDIA has
• 36:03
  Speaker 4: found itself in, in which its customers, there are a
• 36:07
  Speaker 4: couple of different risks that they have. One has been initially,
• 36:10
  Speaker 4: there was a lot of customer concentration in that the
• 36:13
  Speaker 4: hyperscalers were the ones that were buying a lot of
• 36:16
  Speaker 4: its chips. They are trying to continue to diversify that
• 36:19
  Speaker 4: customer base so that if there were slowing CapEx from
• 36:23
  Speaker 4: the big guys, the hyperscalers, that they would be able
• 36:25
  Speaker 4: to make up that revenue elsewhere. You also have the
• 36:27
  Speaker 4: risk with the hyperscalers is that some of them can
• 36:30
  Speaker 4: design these chips themselves, where if you look at Amazon
• 36:33
  Speaker 4: and their Tranium chips, Google has its own TPUs. So
• 36:37
  Speaker 4: they always have the ability to rely on sort of
• 36:40
  Speaker 4: their vertical integration, these big guys. So they need to
• 36:43
  Speaker 4: build up, in NVIDIA's case, other companies that are going
• 36:48
  Speaker 4: to buy from them. And so what they've been doing
• 36:50
  Speaker 4: is they've been using their balance sheet, which has grown
• 36:53
  Speaker 4: tremendously over the course of the last few years, to
• 36:55
  Speaker 4: backstop some of these endeavors that will ultimately lead to
• 36:59
  Speaker 4: more chip sales for NVIDIA. The The potential problem with
• 37:03
  Speaker 4: that approach is that you're transferring the risk from, let's
• 37:07
  Speaker 4: use Anthropic as an example. They are looking to acquire
• 37:11
  Speaker 4: more compute. They have been able to grow their revenue tremendously.
• 37:15
  Speaker 4: It's reported that Anthropic, though private, is an annual revenue
• 37:19
  Speaker 4: run rate of about $ 65 billion. From where they were
• 37:22
  Speaker 4: a year or two ago, that's just tremendous growth. but
• 37:25
  Speaker 4: they can't finance any more of the build-out to get
• 37:28
  Speaker 4: more computing power. They're constrained by their balance sheets. So
• 37:31
  Speaker 4: NVIDIA has basically stepped in, and Anthropic is not the
• 37:33
  Speaker 4: only example of this. They've done it amongst many different
• 37:36
  Speaker 4: companies saying, hey, we got your back. We're going to
• 37:38
  Speaker 4: be the financial guarantor behind a particular build-out for you
• 37:42
  Speaker 4: to get more compute.
• 37:42
  Speaker 3: Let's take a quick break here as we get to
• 37:45
  Speaker 3: the top of the hour, but we got hour two
• 37:49
  Speaker 3: coming up, so stick around.